August 22, 2011 Letter to Shareholders

August 22, 2011

Dear Shareholder:

Will Rogers said, “Eventually you will reach a point when you stop lying about your age and start bragging about it.” Well, I had my eighty-first birthday last month and I guess I’m bragging. I’ve survived somehow, and like all of us, I have had some near misses. But when I look at the current political stalemate and resultant economic turmoil, I have to wonder whether the luck of all of us is not beginning to run out.

Economic historians have always been able to tell us that even sovereign governments cannot continue to spend more than they take in without eventually debasing their currency. This is not the first time Greece, Italy and Spain have collapsed financially. But I guess Will Rogers was right again when he said, “There are three kinds of men: the ones that learn by reading; the few who learn by observation; and the rest of them have to pee on the electric fence and find out for themselves.” (I apologize for the language. That’s what Rogers said.) This latter method seems to be the preferred learning style, not only in Washington, but other places too.

While there are those of the “third kind” who still are in the painful process of learning, the rest of us are left to wonder what we can and should do to protect our joint net worth while the folks over by the electric fence figure things out. Nobody has seen times exactly like today, so it’s difficult to know what to do.

On the subject of U.S. Treasuries, I believe the dollar will continue to be the reserve currency of the world at least for a few more years, and maybe longer. Think about it. How is any other country, including China, going to be able to conduct business without a dollar denominated medium of exchange? When China sells and delivers to us a shipload of typical Walmart goods, we are going to pay them in dollars. If China doesn’t want the dollars, they will have to sell them to somebody who does. When this occurs, the value of the dollar eventually declines under selling pressure and with it the value of China’s international reserves (currently two trillion in dollars) decline as well. I think it will take years for the dollar to be replaced as the international reserve currency. If the dollar remains the reserve currency of the world, I think it follows that U. S. Treasuries will not be badly damaged by a downgrade to AA+ or Aa1 by the rating agencies. The market will probably ignore the downgrade. As this is written, Treasuries are rising in price while the Dow is down about 1,500 points in fear of a double dip recession and a collapsing euro.

Uncertainty in economic performance will be followed by more uncertainty in tax policy. There has always been a proposal somewhere in Washington to eliminate the tax exemption on municipal bond interest or to raise marginal income tax rates. Both are under discussion again in the current Congressional conversations about broader tax-reform, and they both have a better chance of happening now than ever before. If interest on municipal bonds is made taxable, it will make existing tax-free bonds far more valuable. I expect that the existing three trillion (approx.) of outstanding municipal bonds would continue to be tax-free and gradually disappear as they mature or are called; in the process becoming rarer and more valuable. If this comes to pass you will want to hang on to the tax-exempt bonds you have. If marginal income tax rates are raised, tax-exempt bonds will become even more attractive.

There are things we can do to prepare for these possibilities. For example, we opened the Dupree Taxable Municipal Bond Fund last November. This has a higher rate of return on its dividend than any of our tax-exempt funds and makes a very attractive investment for 501(c)(3) charitable and religious organizations. It will also work for IRAs. This new taxable fund makes an excellent investment for organizations currently exempt from income taxes and if tax-exempt municipal bond interest is eliminated, it will make an excellent alternative investment for an individual.

As you may know, we converted to a new shareholder accounting system early this year. A major benefit of this conversion is that we are now able to offer shareholders read-only access to your account through the internet. You can see your account balance, transaction history and statements, etc., but we cannot offer you the ability to make trades online. Go to www.dupree-funds.com , you will find an online access link in the upper right-hand corner which will take you to a page with all the details you need to register your account. Read the instructions carefully. If you feel you need help, email us at info@dupree-funds.com or call us, 1-800-866-0614 or 859-254-7741 and we will help you promptly.

With the uncertainty that currently exists, it does not look to me like the economy is going to make a very significant recovery anytime soon. I don’t see how we are going to avoid the wide swings we are currently experiencing in equities and commodities such as oil and gold, etc. But, with that said, I find it impossible to predict a future of all gloom and doom, at least not in the USA. We will find our way back to sanity eventually.

But while we are waiting for more stable times how should we be invested? With apologies for a bias that should be obvious, let me once again say that you can’t do much better than a managed portfolio of high quality bonds. I emphasize “high quality.” For with high quality comes the assurance of two promises. 1). A promise to pay interest at intervals of, say, six months until maturity and, 2). A promise to pay principal in full at maturity, say ten, or maybe twenty years. But one other condition has to be met. You must be a long term investor; long enough to still own those bonds at maturity. With the payment promises assured, you simply have to keep reviewing the quality of the bonds you own and accounting for the income. That’s where we come in. As they say in Harlan County; “Buddy, we’ll sure enough hep ye with that!” And we will, too!

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