February 25th, 2010 Letter to Shareholders

Digging Beneath the Headlines:

The municipal bond market has continued to generate negative headlines with stories appearing on a regular basis predicting an imminent fiscal meltdown by states and localities. These negative headlines have led to indiscriminate selling in the municipal bond sector which has depressed prices and increased yields. We think it is important to dig beneath the headlines and examine some underlying facts to put things into a proper perspective. Here is some information that we think you should know about the municipal bond market, the recent negative press, and the bonds that we hold in our investment portfolios.

Almost all of the doomsday stories refer to the “municipal bond market” as if it were composed of a single issuer or a single type of bond. Nothing could be further from the truth. The municipal bond market is made up of a multitude of different types of bonds each having their own unique structure and credit quality attributes. For example, highly-rated water and sewer or general obligation bonds are a completely different animal than unrated high-yield community district bonds used by issuers to encourage speculative real estate development. The distinction between investment grade and non-investment grade bonds has largely been ignored by the public press as broad predictions of widespread defaults in the “municipal bond market” have appeared in the press.

The recent default data illustrate why lumping all municipal bonds together is so misleading. A total of seventy nine municipal bonds defaulted in 2010. Thirty six of these defaults were bonds issued by community districts to finance real estate development projects in Florida and California (Source: Distressed Debt Securities Newsletter). According to data compiled by Municipal Market Advisors, over 80% of the municipal bond defaults last year were associated with small unrated bond issues. Bonds issued in connection with for-profit jails, tourist attractions, amusement parks, museums without endowments, lower-rated hospitals, and corporate-backed industrial development projects had the highest default rates.

Historical default data also support the proposition that the vast majority of defaults are typically confined to certain riskier segments of the municipal bond market. Moody’s estimates that the 10-year cumulative average default rate for Moody’s rated investment grade municipal bonds is approximately 0.06% from 1970 to 2009. From 1970 to 2003, three segments of the municipal bond market (corporate-backed industrial development bonds, long-term care/hospitals, and housing) accounted for 81% of all defaults (Source: Fitch). Past performance, of course, doesn’t necessarily guarantee future performance. However, we think the negative headlines are a little misleading.

We’re not saying that there won’t be any defaults because there surely will be some. However, we continue to believe that the overwhelming majority of these defaults will be confined to the riskier segments of the municipal bond market and that the actual number of defaults will be far less than that predicted in the headlines. The good news is that we don’t have any exposure to these riskier segments of the market in any of our investment portfolios. Likewise, none of our single-state municipal bond funds have any exposure to any of the riskier states of Illinois, California, New York, New Jersey, Michigan, and Pennsylvania. The press has also recently highlighted the refinancing risks associated with variable rate municipal bonds that are supported by letters of credit that must be renewed. We don’t own a single variable rate municipal bond in any of our investment portfolios.

In the meantime, states and municipalities around the country are continuing to take the necessary steps to balance their budgets. State and local governments are cutting spending, raising taxes, reducing their workforces, overhauling public-employee pensions, and in some cases eliminating entire state agencies. This is a painful process to be sure. To borrow a phrase from Charles Dickens, “it’s the best of times and the worst of times”. The worst of times is apparent. States and localities are experiencing a tremendous amount of fiscal stress. But, it’s also the best of times in certain respects. Top-quality tax-free bonds are now yielding about the same as comparable corporate bonds and slightly more than comparable U.S. Treasuries, meaning that investors can get higher yields plus tax-sheltered income. Also, for the first time in many years, state and local governments have a chance to reshape government in ways that might not have been politically possible in the past. There may be some truth to the old saying that “adversity breeds opportunity.”

It’s also the best of times in that this is precisely the time that a seasoned professional municipal bond manager like Dupree can add more value. Our job as portfolio mangers is to manage risk. I want to assure you that we are steering clear of the riskier segments of the municipal bond market and staying busy monitoring all of the bonds in our various investment portfolios. Hopefully, the next time you come across one of those scary headlines, it won’t be quite as frightening knowing that we are hard at work protecting your investments.

We appreciate the trust you have placed in us.

Sincerely,

Allen E. Grimes, III

Executive Vice President

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