Municipals Versus Treasuries – A tale of two Cities


The recent price changes in the municipal bond market have potentially created an intriguing opportunity for investors; with municipal bonds selling at relatively enticing yields, even without considering the tax benefits. However, this market is likely to be short lived as investor behavior is stabilizing. In situations of this magnitude, credit research becomes more important than ever and as a result our Portfolio Managers continue to maintain close relationships with bond issuers.

Although municipal bonds tend to be more resilient to economic downturns due to their revenue sources, we consistently monitor portfolio holdings to evaluate their ability to withstand the potential for economic slowdown, and we believe that our portfolios have weathered the most recent market conditions just as we expected. Over the past few weeks, the municipal bond market has experienced a significant sell-off in state and local government debt, despite a climb in global bond prices, as investors struggled to come to terms with the volatile capital markets amidst the uncertainty of the COVID-19 pandemic.

The weakness in the municipal market was amplified by the strength in the Treasury market, resulting in attractive relative yields for municipal bonds. This dislocation is most apparent at the short-end of the yield curve, where 1-year municipal bonds are changing hands at 519% of the yield on Treasuries. This dislocation between municipal bonds and treasuries will not last forever (chart as of 3/20/20).

The strength in the Treasury market has largely been driven by the Fed which has reactivated monetary policies from the 2008 financial crisis in support of our weakening capital markets. The Federal Reserve has stated its intention to buy Treasury securities and agency mortgage-backed securities in “the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” The Fed initially announced its intention to purchase at least $700 billion in asset purchases, of which approximately half of the $500 billion allotment for Treasury purchases was consumed in the first week. It is important to note, that as of the date of this writing, there has yet to be government stimulus in the municipal bond market. On March 24, 2020 the Fed announced support to municipalities through expansion of the Money Market Mutual Fund Liquidity Facility to include variable rate demand notes (VRDNs) and bank CDs, with high-quality tax-exempt commercial paper now eligible for the Fed’s commercial paper facility. However, no other monetary stimulus has been extended to the muni market, which has resulted in the extreme differential of yields. In addition, the Fed will be assuming the role of a commercial bank with the introduction of a Main Street Business Lending Program for small and medium-sized businesses. Collectively, the actions by the Fed reinforce its “whatever it takes” approach and demonstrate broad based support of the capital markets.

Investors have inquired about the impact of the virus on airports, convention centers, hospitals and transit systems. While we agree that there is additional risk to many of the transit and hospitality related credits, our credit research is shifting toward the increasing reality of economic downturn and recession as a credit driver. Our concern is more for an increase in rating downgrades rather than defaults. There are certain credits and sectors, such as higher education and healthcare, where we expect to see limited distress. Furthermore, we expect to see weaker pension funding as pension plans struggle with return assumptions.

Aquila Group of Funds’ seven single-state municipal bond funds are structured defensively to withstand periods of uncertainty with a focus on high-quality holdings and limited duration risk. We continue to see the municipal bond asset class as a viable consideration for investors seeking high-quality, tax-exempt income.


The percentage of portfolio holdings rated AA or higher includes pre-refunded bonds. Fund Characteristics are as of 2/28/20.

Please carefully read the Fund prospectus here. Before investing in one of the Aquila Group of Funds, 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 advisor, or by calling 800-437-1020.

Mutual fund investing involves risk; loss of principal is possible. Investments in bonds may decline in value due to rising interest rates, a real or perceived decline in credit quality of the issuer, borrower, counterparty, or collateral, adverse tax or legislative changes, court decisions, market or economic conditions. Fund performance could be more volatile than that of funds with greater geographic diversification.

Yield refers to the earnings generated and realized on an investment over a specific period of time. Yield is expressed as a percentage based on the invested amount, current market value, or face value of the security, and includes the interest earned or dividends received from holding a particular security.

Yield ratio represents the comparison of the expected yield of one bond to the expected yield of another. A yield ratio is important when deciding whether to invest in one bond or another. Generally, the higher yield is considered better.

Effective duration both measure the value of a security in response to a change in interest rates, and also takes into account the effect of embedded options.

Independent rating services (such as Standard & Poor’s, Moody’s and Fitch) assign ratings, which generally range from AAA (highest) to D (lowest), to indicate the credit worthiness of the underlying bonds in the portfolio. Where the independent rating services differ in the rating they assign to an issue, or do not provide a rating for an issue, the highest available rating is used in calculating allocations by rating. Pre-refunded/Escrowed bonds are issued for the purpose of retiring or redeeming an outstanding bond issue at a specified call date. Until the call date, the proceeds from the bond issuance are typically placed in a trust and invested in US Treasury bonds or state and local government securities. Non-rated bonds are holdings that have not been rated by a nationally recognized statistical rating organization.


New Podcast: Recent Muni Market Volatility


We sat down with Portfolio Manager, Tony Tanner, CFA®, on March 17th to get his insight on the ongoing volatility in the municipal bond market and how the current conditions compare to prior periods of instability. Tony began his buy-side career managing two flag-ship single-state municipal bond funds in the early 1990s, and he has managed through a variety of volatile municipal bond markets, including the bond bear markets of 1994, 1999, 2008 & 2016. The podcast is linked below, and the full transcript is available here.

Manager Commentary

Aquila Funds Podcast

Length 20:25

Share | Download | Transcript
Aquila Funds

Tony Tanner

Portfolio Manager
Aquila Tax-Free Trust of Arizona

Please carefully read the Fund prospectus here. Before investing in one of the Aquila Group of Funds, 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 professional, or by calling 800-437-1020.

Please see the most recent quarter-end performance for the Aquila Tax-Free Trust or Arizona here. Most recent month-to-date performance is on this site. Performance data represents past performance, but does not guarantee future results. Investment return and principal value will fluctuate; shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the data presented. Class A shares have a maximum sales charge of 4.00%; Class A MOP (maximum offering price) returns reflect deduction of the maximum 4.00% sales charge; Class A NAV returns do not reflect deduction of the sales charge and would be lower if that charge were reflected. A full description of share classes may be found in the prospectus

Mutual fund investing involves risk; loss of principal is possible. Investments in bonds may decline in value due to rising interest rates, a real or perceived decline in credit quality of the issuer, borrower, counterparty, or collateral, adverse tax or legislative changes, court decisions, market or economic conditions. Fund performance could be more volatile than that of funds with greater geographic diversification.


A Perspective on Recent Muni Market Volatility


The municipal bond market experienced one of its most disruptive and volatile market periods in recent memory during the week of March 9, 2020. After steadily moving higher for past 15 months as the Federal Reserve initiated a new easing policy, municipal bond prices declined sharply last week in response to increased economic disruption brought about by the rapidly evolving coronavirus pandemic.

The volatility in municipal bond prices and municipal bond fund mutual funds last week was indeed both abrupt in its speed and significant in magnitude. However, such municipal bond market behavior has in fact occurred on several occasions in the past thirty years. In the context of these prior periods, the price and trading activity in the municipal market last week reflected the very “normal” manner in which the municipal bond market has behaved in “abnormal times”.

Also in the context of the overall municipal bond market, the intermediate maturity and investment grade mandate, in which all Aquila municipal bond fund portfolios are structured, helped deliver less fluctuation than that of long term bonds last week.

Unusual – But Not Unprecedented

On March 12, 2020, the Net Asset Value of the Aquila Tax-Free Trust of Arizona’s (ATFTA) Class A Share declined 2%. This compared to long term bond funds who suffered Net Asset Value (NAV) declines of as much as 3%, and large actively traded national municipal bond Exchange Traded Funds (ETFs) which dropped 5% that day. This greater degree of downside stability reflected the benefits of both the intermediate mandate and very broadly diversified portfolios that are the foundations of our locally managed municipal bond funds. You may find the Fund’s latest performance here.

This magnitude of one-day price fluctuation was not unprecedented though. On Tuesday April 4, 1994 intermediate and long term municipal bond NAVs also declined 3%-4%. I had the opportunity to experience this market turmoil firsthand while co-managing two investment grade, single-state bond funds with short term and long term maturity mandates at the time. On that day, coming off an extended Easter holiday weekend, the Federal Reserve made a surprise increase in the discount rate as part of a significant monetary tightening they had started at the beginning of 1994.

By the end of that Tuesday, the 10-year US Treasury bond yield increased 39 basis points from 6.75% to 7.14%, and the 30-year US Treasury bond yield spike 32 basis points, from 7.10% – 7.42%. The Bloomberg Barclays AAA 10-year Maturity Index yield rose a more modest 25 basis points. This sudden spike in yields along with very thin trading activity in a volatile market translated into the sharp NAV declines of that day. The Class A Share of ATFTA declined 19 cents that day, fairly commensurate with the unusually large one day declines experienced last week. One difference in these two periods is that last week’s volatility was induced by significant economic stress, rather than Federal Reserve policy and the long term direction of benchmark interest rates. Last week also shared common themes with the height of municipal market volatility that occurred near the end of 2008 during the great recession.

Over a three-week period from the week of November 18th to December 15th in 2008, the NAV of ATFTA declined 4.4% as the shadow of corporate bankruptcies and bailouts weighed on the municipal bond market. Long-term funds suffered even sharper declines of as much 7%. Again, we believe an intermediate maturity focus and portfolio breadth helped to mitigate a good degree of the downside risk of this period.

What was mostly unusual about this period was that US Treasury bond yields moved significantly lower throughout this period as the Federal Reserve aggressively moved to inject liquidity into the market. For example, 10-year US Treasury bond yields declined from 3.77% to 2.51% even as comparable AAA municipal bond yields increased 32 basis points to 4.44%. The polar opposite behavior of these markets was even more pronounced in the long end of the yield curve. Benchmark 30-year US Treasury yield declined from 4.23% to 2.95%, while the Bloomberg Barclays AAA 30-year Maturity Index yield increased 63 basis points to 5.77%.

The Return of Genuine Relative Value

This window of volatility behavior near the end of 2008 was similar to what the muni market experienced last week, as the increase in municipal bond yields were double those of benchmark US Treasury bonds. This resulted in a significant underperformance of the municipal bond market that has left municipal bond yields at compelling valuations which are reminiscent of those in December 2008.

As of this writing, Bloomberg Barclays Fair Value 10-year and 30-year AAA municipal bond index yields equal 210% and 173% of comparable maturity US Treasury bonds. In December 2008, those same yield ratios were 177% and 196% respectively. For real market perspective, look at the yields offered in a $709 million Salt River Power Authority Bond issue that came to market the week of January 12, 2009:

The Search for Value is Not a Predictive Exercise

It is important to put municipal bond price volatility, elevated municipal bond yields, and tax exempt/taxable yield ratios in their proper perspective. In prior thought leadership papers, we have pointed out the importance of components of return in fixed income investing. In particular, it is important to keep in mind that the lion’s share of long run total return in municipal bond investing is derived from the income. The corollary is that over the long run, price changes contribute a small amount towards, and only detract a small amount from, total return.

Total Return Breakdown of the

Bloomberg Barclays Municipal Bond Index Since Inception 

Over the very short run (like a very volatile week in March of 2020, or day in April 1994) prices changes can overwhelm income. This is even more true today than in the much higher interest rate landscape of the 1990s and 2000s. Which makes evaluating and staying committed to a well thought out asset allocation plan vital. Doing so enables investors and advisors alike to focus on whether the fixed income tool in an asset allocation plan can provide an attractive level of income after taxes that protects purchasing power, while mitigating a large degree of volatility across the fixed income and equity universe.

Given current stock market volatility and the wild swings in taxable bond prices of the past week, conservative and consistently managed municipal bond portfolios appear to now offer enhanced long run value. Such value is not a guarantee against further fluctuation or price declines, but rather an indicator of the degree to which municipal bonds may be able to assist in the achievement of overall asset allocation objectives.

Over the next several weeks, we look forward to sharing further insights into a few of the market dynamics that are unique to the municipal bond asset class, how they shape municipal bond price fluctuations, and the opportunities they present that a local management perspective can capitalize on for shareholders. Read more “A Perspective on Recent Muni Market Volatility”


Municipal Bond Fund Shareholder Meeting Updates


Aquila Group of Funds has been hosting regular shareholder meetings for our seven municipal bond funds since each Fund’s inception. In light of the CDC’s advice to limit group gatherings to less than 50 people for the next 8 weeks, we are canceling our spring meetings planned for Aquila Churchill Tax-Free Fund of Kentucky, Aquila Narragansett Tax-Free Income Fund and Aquila Tax-Free Fund of Colorado. Thank you for understanding while we navigate these difficult and changing impacts of COVID-19.


Aquila Group of Funds Remains Fully Operational


As the United States responds to the unprecedented COVID-19 outbreak, we want to assure you that Aquila Group of Funds is fully operational and committed to providing the exceptional customer service for which we are known. Following guidance from the Center for Disease Control and Prevention (CDC), we executed a remote working policy for all employees beginning March 16, 2020.

In addition to closely monitoring the latest developments, our leadership team is in continuous contact with our business partners, transfer agent, Fund advisors and Fund sub-advisors to ensure we have complete information and the knowledge needed to make effective decisions as we respond to the current threat. The safety and well-being of our employees, our shareholders and the financial professionals who depend on us are our main concern at this time, and we sincerely hope that everyone remains healthy as we all work to mitigate the spread of COVID-19.


Demographic Trends Affecting the Higher Education Sector


Vasilios Gerasopoulos is Vice President, Credit Analyst with Davidson Fixed Income Management, the sub-adviser to Aquila Tax-Free Fund of Colorado, doing business at Kirkpatrick Pettis Capital Management in Colorado. 


In recent years, skyrocketing tuition and declining enrollment rates have heightened concern around higher education bond issues. Approximately 30% of universities have rated bonds. Of those that are rated, 91% are investment grade and 66% are rated ‘AAA/AA’. As Portfolio Managers of Aquila Tax-Free Fund of Colorado, we continue to be selective of the higher education credits we are willing to hold, and we closely monitor the higher education holdings in the Fund, which currently comprise approximately 14% of the portfolio.

We recently attended the National Federation of Municipal Analysts Seminar on Higher Education. The Seminar took place in January 2020, and included investors, academics, practitioners and bond issuers who discussed concerns in higher education. One of the panels discussed future demographic challenges for higher education, including:

• Increasing high school graduation rates, but declines in the total numbers of graduates, which is magnified in certain geographic regions.
• Trends impacting enrollment, including immigration and migration within states and regions, and policy shifts.
• The changing racial and ethnic demographics of postsecondary students.
• Shifting environmental circumstances such as the demand for certain skills, job automation, and changing economic conditions.
• State and endowment funding challenges

Nationally, the increase in higher education costs continues to exceed the rate of growth for all other household expenditures. As a result, universities and colleges are looking to attract international students, and applicants from outside of their historical boundaries, through recruitment, remote campuses, and direct employer contracting. These efforts are expected to help mitigate the anticipated enrollment decline of traditional 18-22-year-old students. Read more “Demographic Trends Affecting the Higher Education Sector”


Hawaiian Tax-Free Trust Turns 35


This February, Aquila Group of Funds celebrated the 35th Anniversary of Hawaiian Tax-Free Trust, the company’s flagship municipal bond fund. Aquila’s founder, the late Lacy Herrmann, was one of the earliest creators of single-state, tax-free municipal bond funds. He recognized the need for double tax-free income in states with high income tax rates, and brought a new perspective to the asset class with a focus on local involvement.

In 1985 Mr. Herrmann led Aquila in partnering with Hawaiian Trust Company (acquired by the current Trust Advisor, Bank of Hawaii) to secure, and hire a local Portfolio Management team to oversee the Trust’s portfolio of investments given their deep knowledge of Hawaii municipal issuers and close proximity to the projects which shareholders’ money would finance. He also carefully selected a Board of Trustees to govern the Trust which included local Hawaii professionals from various business backgrounds, representing Hawaii’s diverse population.

Sherri Foster, a resident of Maui, joined the Aquila team prior to the Trust’s launch to work with local Financial Professionals and Shareholders. She was interviewed in the article Island Hopping, and continues to represent Aquila Group of Funds and Hawaiian Tax-Free Trust today.

When asked about the time in her role, Sherri said:

“I am proud to represent the first and largest Hawaii municipal bond fund, “HTFT”, as a shareholder and Regional Sales Manager since the opening day on February 20, 1985. My role working with financial institutions across our state has given me the opportunity to build many relationships and make friends with financial professionals and shareholders alike. I love my job, and say Mahalo to everyone who has supported us for the past 35 years.”


If you’ve passed by the Kahului Fire Station on Maui, visited the Kona Community Aquatic Center on the Big Island or driven on the H-3 Freeway on Oahu, you’ve seen some of the many projects that Hawaiian Tax-Free Trust shareholders have helped build over the years. The Trust has financed highways, hospitals, bridges, airports, water treatment facilities, convention centers and many other projects across the islands, while providing investors the highest possible level of income exempt from Hawaii state and federal income taxes, consistent with preservation of capital.

Kahului Fire Station on Maui

H-3 Freeway on Oahu

Following the launch of Hawaiian Tax-Free Trust, Aquila launched six additional single-state municipal bond funds between 1986 and 1992; all of which still serve shareholders in Arizona, Colorado, Kentucky, Oregon, Rhode Island and Utah. Today, Aquila’s mutual fund line-up consists of nine funds, including a high-yield corporate bond fund and an equity fund, but the company’s reputation for exceptional customer service, and conservative asset management, is rooted in the disciplined investment approach of managing locally based municipal portfolios through various market cycles for over three decades.

You can learn more about Aquila’s disciplined management approach and our commitment to the shareholders and financial professionals we serve by reading our company brochure, A Careful Approach for Today’s Markets, and our Guiding Principles on this website. Read more “Hawaiian Tax-Free Trust Turns 35”


The Arizona Municipal Bond Monsoon


Arizona municipal bonds were plentiful in the new issue market during 2019. In fact, it turned out to be the busiest year for new municipal bond issuance in the state for the entire decade. A total of $7.9 billion of new municipal bonds from Arizona’s state and local governments came to market, eclipsing the previous high of $7.5 billion that came to market in 2016. That year, issuers accelerated their borrowing in advance of the 2016 election and potential tax law changes that were expected to limit municipal borrowing.

Revenue bonds dominated 2019 issuance, comprising 83% of the total in Arizona, which is not surprising. Unlike larger states like Illinois and Texas, Arizona does not issue tax-supported general obligation debt. In fact, only about 10% of the approximately $44 billion in outstanding munis in Arizona are state-related obligations.

New municipal bond issues were dominated by the Education, Healthcare, and Transportation sectors, whose capital projects and borrowing needs are most associated with a rapidly growing population. These three sectors accounted for 63% of the total issuance and almost 70% of the new deals brought to market.

We have highlighted the population growth in Arizona, led by Maricopa County, in recent Aquila Tax-Free Trust of Arizona investment commentaries. Well thought out new construction, expansion, and maintenance capital projects are vital to both enhancing the basic service needs and necessary infrastructure facilities that maintain the quality of life for Arizona residents. Read more “The Arizona Municipal Bond Monsoon”


We Recognize and Celebrate Three Retiring Trustees


At Aquila Group of Funds, the hallmark of our time-tested municipal bond fund strategy has always been our local presence in the markets in which we invest. Included in that local presence are the members of our Boards of Trustees who reside in the states where we manage mutual funds.

Mutual fund boards are the champions of shareholders, and for over 35 years Aquila Group of Funds and our respected Trustees have been shareholder focused. In December, our company recognized the pending retirements of three esteemed independent Trustees, Mr. Richard L. Humphreys, Mr. Russell K. Okata, and Mr. Ralph R. Shaw.

Mr. Richard L. Humphreys, retired from the board of Hawaiian Tax-Free Trust, effective December 31, 2019, after having served as a Trustee since 2009 and Chair of the Board since 2013. Mr. Humphreys is President of both Hawaii Receivables Management, LLC, a factoring company, and Lynk Payment Systems Hawaii, LLC, a credit card processing firm. Among other executive roles in banking and finance, he was formerly Chairman of Bank of America, Hawaii, President of Hawaiian Trust Company (the original investment adviser of Hawaiian Tax-Free Trust, which later merged with the Trust’s current adviser, Bank of Hawaii), President of First Federal S&L and Executive Vice President of Bank of Hawaii. Mr. Humphreys is currently serving and has previously served on the board of directors of a broad variety of local organizations, including Kahua Ranch Ltd. His considerable business experience and valuable business insight have greatly benefitted Aquila Investment Management, his fellow Trustees, and shareholders.

Mr. Russell K. Okata retired from the board of Hawaiian Tax-Free Trust and the board of Aquila Funds Trust, effective December 31, 2019. Mr. Okata joined the board of Hawaiian Tax-Free Trust in 1992, and was a Trustee of Pacific Capital Funds of Cash Assets Trust (three former money-market funds in the Aquila Group of Funds) from 1993-2012. In 2007, Mr. Okata joined the board of Trustees of Aquila Three-Peaks High Income Fund, and later became a Trustee of Aquila Funds Trust which oversees both Aquila Three Peaks Opportunity Growth Fund and Aquila Three Peaks High Income Fund. During his tenure as Trustee, Mr. Okata was a member of the Judicial Council of Hawaii and served as a director of various civic and charitable organizations. He was the Executive Director of Hawaii Government Employees Association and the International Vice President of American Federation of State, County and Municipal Employees from 1981 – 2007. Mr. Okata’s experience in local government affairs and his knowledge of Hawaii has been invaluable to the boards and shareholders he served.

Mr. Ralph R. Shaw retired from the board of Aquila Tax-Free Trust of Oregon, effective December 31, 2019, after having served as Trustee since 2000. During his tenure as a Trustee, Mr. Shaw served in a variety of leadership roles including as Audit Committee Chair since 2002. Mr. Shaw’s prestigious and varied background included extensive experience in the securities business and as a member of the board of directors of a number of companies throughout the country, including Rentrak Corporation, a global media research company. He has served as a leading venture capitalist in the Pacific Northwest, backing a broad variety of companies including Costco. Mr. Shaw is owner of Shaw Management LLC, and was President of Shaw Management Company, an investment counseling firm, from 1980 – 2018. His extensive business experience and insight have greatly benefitted his fellow Trustees and the Fund’s shareholders during his time as Trustee.

On behalf of the Funds, we express our sincere appreciation and gratitude to each of these retired Trustees. All three individuals, over their tenure as Trustee, brought a high level of dedication and professionalism to their role as a fiduciary on behalf of fund shareholders. We are very proud to have worked with them, appreciative of their years of service, and we wish them well in all of their future endeavors.


Take a Closer Look at this Mid Cap Fund


Aquila Three Peaks Opportunity Growth Fund had a notable year in 2019. It was recognized by The Wall Street Journal as a Mid Cap Core Category King during the months of May, July, August, October, November and most recently for one-year performance as of December 31, 2019, when the Fund ranked 5th out of 360 funds in the Lipper Mid Cap Core equity category with a total return of 35.9%. The Fund was also recently recognized by Investor’s Business Daily on a list of growth funds leading the market. We credit this success to our distinctive management process that is rooted in intense research and built on our experience in the high yield market. See the Fund Fact Sheet for quarter-end standardized performance.

In selecting investments for Aquila Three Peaks Opportunity Growth Fund, we begin with the universe of companies we know best – those we follow in managing Aquila Three Peaks High Income Fund. We look for issuers of high-yield corporate debt and companies generating free cash flow and improving the corporate balance sheet by paying down debt.

We attempt to mitigate risk by looking for companies in industries with relatively consistent revenue generation (non-cyclical industries), that have demonstrated the ability to grow even in a low-growth economy. Our strategy is to maintain a broadly diversified, well researched, well balanced portfolio to reduce volatility. We implement this strategy through a fundamental, bottom-up analysis of each company in which we invest.

If you are looking for an equity fund with a management strategy unlike many of its peers, take a closer look at Aquila Three Peaks Opportunity Growth Fund. Read more “Take a Closer Look at this Mid Cap Fund”