During the first quarter of 2017, while many Americans were trying their best not to think about the looming tax season, the team at Oppenheimer Rochester continued to do what it does best no matter the season: Deliver competitive levels of tax-free income.
The municipal bond market was more cooperative in the first three months of this year than it was in the last three of 2016. The overall market produced a first-quarter total return of 1.58%, according to the Bloomberg Barclays Municipal Bond Index.1
Though modest relative to the performance of the U.S. equities markets, the positive total return represents a welcome relief to those fixed-income investors who were concerned about how price declines in the latter half of 2016 were affecting net asset values (NAVs) and performance.
The high yield tobacco sector, which rallied sharply in 2016, continued to be a bright spot in the market year to date. Tobacco bonds helped drive performance among the muni funds that invest in its securities, which are backed by the proceeds of the landmark Master Settlement Agreement (the MSA). The Bloomberg Barclays index of high-yield tobacco bonds produced a total return of 13.12% for the quarter. Our team has a nuanced understanding of the MSA, and our funds’ overweight tobacco holdings have delivered significant shareholder value over the years. Overall, first-quarter market performance was held back by pricing pressure in other muni sectors.
During the first quarter, high-grade muni bonds continued to provide a yield advantage versus U.S. Treasuries with comparable maturities. AAA-rated muni bonds with maturities of 15 years and more as of March 31, 2017 provided higher levels of yield – on a nominal basis – than U.S. Treasury bonds with the same maturities. On an after-tax basis, the yield difference would further benefit muni investors because income from Treasury securities is taxed by the federal government while the net investment income from munis is not.
Retail investors should note that foreign buyers increased their muni investments during the fourth quarter of 2016, according to Federal Reserve data released in March. They recognize that munis are an attractive asset class, even without the tax exemptions that appeal to U.S. retail investors.
In other news, market volume pulled back in the first quarter of the year. At $87.9 billion as of March 31, 2017, issuance was 15.5% lower than during the previous quarter and 12.0% lower than it had been the first quarter of 2016.
At the outset of March, Federal Reserve officials made a series of seemingly coordinated remarks that dampened Wall Street’s spirits in the weeks before the Fed’s subsequent decision to raise the target range for the Fed Funds rate, the short-term interest rate that it controls. By setting the range at 0.75% to 1.00%, the highest it has been since mid-December 2008, the Fed revealed its concerns about the pace of economic activity. Our portfolio team does not manage the 20 Rochester funds based on predictions of interest rate changes. As long-time investors know, a change in the Fed Funds rate does not automatically translate into a change in longer-term interest rates.
Also during the quarter, the new governor of Puerto Rico, Ricardo Rosselló submitted a new fiscal plan to the Oversight Board that had been established under PROMESA, the Puerto Rico Oversight, Management, and Economic Stability Act of 2016. U.S. legislators continued to monitor progress on several fronts, including pending litigation and the 2015 restructuring agreement between PREPA (Puerto Rico’s electric utilities authority) and its forbearing creditors, including Oppenheimer Rochester.
All of these topics kept the Commonwealth of Puerto Rico in the headlines throughout the first quarter of the year and, given how dynamic the situation remains, we expect investors will continue to see media coverage about the Commonwealth. Our team will continue to work to protect our shareholders’ best interests. More detailed information about the developments covered below can be found on our online PR Roundup.
At the end of the quarter, the Trump administration tabled its effort to repeal the Patient Protection and Affordable Care (aka Obamacare). Thus, for the time being at least, the net investment income generated by muni bonds and muni bond funds will remain exempt from the 3.8% tax on unearned income that applies to net investment income from other types of investments. The administration has said that tax reform will be next on its legislative agenda. Given that the typical muni investor pays a marginal federal tax rate of 25%, President Trump’s focus on lowering higher tax brackets should not alter the tax advantages that muni investments offer these investors.
Finally, we hope shareholders will indulge us as we close with information about some honors that were bestowed on the Rochester funds during the first quarter.
At the Thomson Reuters Lipper Fund Awards ceremony in March, 12 Oppenheimer Rochester funds won 17 best-in-class awards based on consistent returns for the 3-, 5- or 10-year periods ended November 30, 2016 within their respective peer categories.2 Details can be found here.
We thank you, our shareholders, for continuing to entrust us with your assets.
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1 The Bloomberg Barclays Municipal Bond Index is an unmanaged index of a broad range of investment-grade municipal bonds that measures the performance of the general municipal bond market. Index performance is shown for illustrative purposes only and does not predict or depict performance of the Fund. Past performance does not guarantee future results.↩
2 Lipper Awards are granted annually to the funds in each Lipper classification that achieve the highest score for Consistent Return, a measure of funds’ historical risk-adjusted returns, measured in local currency, relative to peers. Winners are selected using the Lipper Leader rating for Consistent Return for funds with at least 36 months of performance history as of 11/30/16. Awards are presented for the highest Lipper Leader for Consistent Return within each eligible classification over 3, 5 or 10 years. Other share classes may have different performance and expense characteristics. Although Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Lipper. Lipper awards are not intended to predict future results. Past performance does not guarantee future results.↩
3 To be considered, each firm must offer a wide range of funds with a minimum track record of one year. Further, the firm must offer at least three mutual funds or ETFs in Lipper’s General U.S. Equity category, at least one mutual fund or ETF in Lipper’s World Equity category; at least one in one of Lipper’s Mixed-Asset categories; at least two taxable bond funds and at least one tax-exempt bond fund.↩
Fixed income investing entails credit and interest rate risks. Interest rate risk is the risk that rising interest rates, or an expectation of rising interest rates in the near future, will cause the values of a Fund’s investments to decline. Risks associated with rising interest rates are heightened given that rates in the U.S. are at, or near, historic lows. When interest rates rise, bond prices fall and a fund’s share price can fall. Municipal bonds are subject to default on income and principal payments. Further, a portion of some funds’ distributions may be taxable and may increase alternative minimum tax (AMT) for investors subject to that tax; distributions from net realized capital gains are taxable as capital gains.
The funds invest in below-investment-grade debt securities, which may entail greater credit risks, as described in each fund’s prospectus. These securities (sometimes called “junk bonds”) may be subject to greater price fluctuations and risks of loss of income and principal than investment-grade municipal securities. The funds may invest substantially in municipal securities within a single state or related to similar type projects, which can increase volatility and exposure to regional issues. The funds may also invest substantially in Puerto Rico and other U.S. territories, commonwealths and possessions, and could be exposed to their local political and economic conditions. Deterioration of the Puerto Rican economy could have an adverse impact on Puerto Rican bonds and the performance of the Rochester municipal funds that hold them.