03/21/2019

Understanding Interest Rate Risk in Bond Funds

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After almost a decade of extremely accommodative monetary policy from the Federal Reserve, with a zero-bound Fed Funds target rate, the Fed began increasing rates in December of 2015, and since then, rates have increased 10 times by a total of 225 basis points. Fed Chair Powell indicated after the March Federal Open Market Committee meeting that we will not see additional rate increases in 2019, but understanding interest rate risk remains an important aspect of investing in bond funds.

A common misconception of investing in bond funds is that when interest rates rise, bonds fall out of favor. While the inverse relationship between interest rates and bond prices does exist, there are many factors to consider when making a decision about current and future bond holdings – and whether to hold individual bonds or invest in a bond mutual fund.

Duration

A bond fund’s duration, specifically modified duration, is an indicator of how sensitive the net asset value is to a change in interest rates. Duration provides investors with another aspect of comparison between bonds with different maturities and coupon rates. Simply stated, for every 1% change in interest rates, positive or negative, the price of a bond fund will inversely decline or increase by its modified duration. For example, if a fund’s modified duration is 5 years, the net asset value could be expected to rise 5% for every 1% decline in interest rates, and fall by 5% for every 1% increase in interest rates. Bond funds with longer average maturities and lower average coupons have a longer duration, and therefore generally experience a higher degree of price fluctuation, while bond funds with shorter average maturities and higher average coupons have a shorter duration and generally experience a lesser degree of price fluctuation.

Price Returns and Total Returns

The good news is that performance of bond funds is not solely tied to the incremental changes in interest rates. Bond fund total returns are generated from two sources; interest payments on bonds (paid as fund distributions) and changes in bond prices. While interest rates rise, active portfolio managers have opportunities to purchase bonds at higher yields, and over time, a portfolio’s income may off-set a decline in the value of individual bonds, mitigating the impact of that decline on a Fund’s total return.

Since its inception in 1980, approximately 98.7% of the Bloomberg Barclays Municipal Bond Index total return has been generated by income.

 

Active Bond Fund Management

Periods of rising rates can be challenging for investors who purchase individual bonds or funds aligned with a bond index. Active bond fund managers have the ability to take strategic steps in an effort to mitigate, to some degree, the impact of market volatility. With the ability to actively manage fund holdings over time, these managers may implement a number of strategies in order to adjust fund holdings based on market expectations. Fund holdings may be altered by quality rating in an effort to manage credit risk – a risk which may increase along with rising rates. Holdings may also be altered by maturity date and coupon, thereby adjusting portfolio duration, or the sensitivity of the portfolio to movements in rates. Reducing portfolio duration would reduce sensitivity to a change in rates.
Read more “Understanding Interest Rate Risk in Bond Funds”

06/14/2017

Active and Passive Management: A Blended Approach

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Building BlocksA heightened focus regarding fees and investor protection has generated an increased number of headlines around the decades-old debate between active and passive fund management. Historically, investors have viewed the two theories of management as one-verses-the-other, and many investors have been known to fluctuate between the two based on which style is in favor; in recent years, the trend has tilted toward passive management. Lower volatility, monetary policy and economic recovery have made it more difficult for active managers to consistently beat their benchmarks. However, history tells us that when passive management becomes oversaturated, the pendulum often swings back toward active. While we don’t anticipate a major shift away from passive, there are attractive aspects of active management that should be considered – and we believe that a combination of both styles creates a strong and timeless portfolio.

The shift to passive fund management

Investing in passive mutual funds is unquestionably a way to reduce investment fees that can drag on fund performance while maintaining exposure to a wide variety of investment styles. Fee-conscious investors, Financial Advisors and Broker Dealers are all embracing the idea of balancing less active portfolio management and research against the potential of earning benchmark returns from simply tracking the overall market.

Passive funds are particularly attractive in areas where markets are extremely efficient, where information is readily available, and where the ability to uncover opportunities to beat the market is rare. Take the U.S. large-capitalization segment for example; only 5% of portfolio managers in that segment who beat their index for three consecutive years also beat their index the following three years, according to S&P Dow Jones Indices*. Passive funds can also be an attractive tax-efficient investment; particularly those that track more narrowly focused benchmarks.

Overall, the mutual fund industry has benefited from the increase in the number of passive funds. Low-cost providers have driven down the cost of active funds, while sharpening the focus of active managers on performance and fund expenses.

Do investors still benefit from active management?

We think so. While passive funds may be attractive from a fee and tax-efficient standpoint, they do have drawbacks. Markets have inefficiencies, which passive managers cannot exploit. Managers following an index lack the ability to make adjustments based on market conditions and research discoveries. For instance, active managers can judge when to raise cash levels, in order to reduce potential downside exposure, when markets react to external events. Active managers also have the ability to weight holdings according to where they see value, while most passive approaches are weighted to align with the chosen index, for instance by market capitalization – giving more exposure to well-established companies that may have less growth potential.

Read more “Active and Passive Management: A Blended Approach”

06/24/2016

Brexit – Day One

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Global financial markets were turbulent during the first day of trading following the United Kingdom vote to leave the European Union.

Amid the market uncertainty, investors moved assets to the safety of U.S. government bonds, pushing prices higher and yields lower.   Yield on the 10-year Treasury note dropped to an intra-day low of 1.419% (near its record low yield of 1.404%), but by the end of the day, the yield on the 10-year Treasury was 1.575%; down from 1.745% on the previous day.

Thomson Reuters Municipal Market Data reported that municipal bond yields reached all-time lows, with the benchmark 30-year AAA dropping to 2.08%.  Total return on the Barclays 10-Year Municipal Index was 0.82% for June 24th with a yield to worst of 1.57% versus 1.70% on June 23rd.

During periods of market turbulence, a ‘flight to quality’ on the part of investors has resulted in buying US Treasuries and, to a lesser degree, municipal bonds.  That demand typically drives prices higher and yields lower.  Although the Federal Reserve had previously indicated that another rate increase was possible in 2016, it now appears that any increase could be postponed until late 2016 or sometime in 2017. Read more “Brexit – Day One”

08/04/2015

Aquila Municipal Bond Funds Continue to Avoid Puerto Rico Debt

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Each of the municipal bond funds offered in the Aquila Group of Funds adheres to an investment strategy focused on investment grade bonds as a means of managing credit risk, and an intermediate average portfolio maturity as a means of managing interest rate risk. In keeping with our emphasis on high-quality holdings, the seven state-specific municipal bond funds offered by Aquila have no Puerto Rico holdings, whereas Morningstar has reported that over 20% of US Bond Funds had roughly an $11.3 billion total exposure to Puerto Rico debt as of 3/31/15; down from two-thirds of funds having exposure a year ago.

On Monday June 29th, Puerto Rico’s Governor Alejandro Garcia Padilla announced that the territory’s approximately $73 billion in municipal debt is unpayable and called for concessions from creditors. Moody’s downgraded Puerto Rico’s general obligation debt into junk territory with a negative outlook on July 1, 2015, which was the seventh downgrade in five years.

On the Aquila Group of Funds website, you will find information regarding the investment strategies and full portfolio holdings of each state-specific municipal bond fund. The investment objectives, risks, charges, expenses, and other information will be found in the Fund prospectus. Information on the Fund holdings will be found in the Fact Sheet, Annual and Semi-Annual reports, and the Portfolio Holdings report. We encourage you to review this information, and to visit the web site frequently for updates on each fund, and our perspectives on the markets.

07/15/2015

A New Approach to Bonds

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The July 11, 2015 issue of Barron’s features a cover story on investing in bonds which includes a favorable perspective on municipal bonds, amid general concerns regarding rising rates.  While the timing and magnitude of a future Fed Funds rate increase is still uncertain, expectations cluster around a 0.25% increase in September, 2015.  If we do see a rate increase in September, it won’t be the first time that rates have gone up.  Over the past 30 years, interest rates have been declining, but that general trend is marked by periods in which the Fed Funds rate rose by as much as 4%.

The head of a fixed-income asset management company is quoted in the Barron’s article, saying “the rich are getting richer, and they’re getting older”.  The point relates to demand for municipal bonds in that there is a growing population of aging investors attracted to the tax-exempt income offered by municipal bonds.  Recently, the supply of municipal bonds has declined as municipal issuers have worked to manage their budgets.  Supply is likely to decline further in an environment of higher rates which increase the cost of borrowing for these issuers.  Limited supply and heightened demand can provide support for prices. Read more “A New Approach to Bonds”

04/21/2015

Rhode Island State Treasurer, Seth Magaziner, speaks to Fund shareholders

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During the Aquila Narragansett Tax-Free Income Fund Annual Shareholder meeting on April 2, 2015, Rhode Island State Treasurer, Seth Magaziner spoke to attendees, sharing his observations on the economy in Rhode Island.  He pointed out that the financial position of the state is steadily improving, having reached a turning point with a new sense of optimism in the air.  Read more “Rhode Island State Treasurer, Seth Magaziner, speaks to Fund shareholders”

02/04/2015

Todd Curtis Shares 2015 Expectations in Asset TV Municipal Bond Masterclass

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On January 20, 2015, Asset TV produced a Municipal Bond Masterclass in which a panel of municipal bond fund portfolio managers was asked to discuss their expectations of the municipal bond market in 2015 and their investment strategies.

Todd Curtis, Senior Vice President and Portfolio Manager or Co-Portfolio Manager of Aquila Tax-Free Trust of Arizona, Aquila Churchill Tax-Free Fund of Kentucky and Aquila Tax-Free Fund For Utah participated as a panelist. The following video includes highlights from his comments.

Shares of the Funds may only be sold by offering the Funds’ Prospectus. Before investing in a Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus. The prospectus is available on this site, from your financial adviser, and when you call 800-437-1020.

10/31/2014

PERS Reforms to be Considered by the Oregon Supreme Court

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We believe that one of the benefits of having a portfolio manager and analyst located in the market in which Aquila Tax-Free Trust of Oregon invests, is the opportunity this provides to closely follow public policy developments and legislation, in addition to the financial condition of municipal bond issuers.

Developments related to the Public Employee Retirement System (PERS) provide an example.  In 2013, the Oregon Legislature enacted PERS reforms that reduced the cost-of-living adjustment for all retirees, and eliminated tax remedy payments for beneficiaries who do not live in Oregon and are therefore not subject to Oregon state income tax. These provisions will be considered by the Oregon Supreme Court early in 2015.  While it is possible that the Court could reverse the PERS reforms, we currently view that as the less likely outcome. Read more “PERS Reforms to be Considered by the Oregon Supreme Court”