June 30, 2010 Shareholder Letter

Dear Shareholder:

For the past two years, every time we have written a shareholder letter we have found it necessary to reassure folks who were being frightened by the screaming negativity that surfaces in headlines of articles about municipal bonds. Headlines such as “Survey highlights risk of municipal defaults”, ”States are going bankrupt”, “Inflation expected to be rampant”, and so on have become commonplace.

If you actually read the entire article, most of the time you will generally find a more balanced statement. But headline writers are never balanced! Their job is to sell the article. They are interested in attracting your eye to that particular item, and they are not at all above sensationalism. I think it is time for some of these headline writers to reread the children’s classic Chicken Little, who worried that the sky was falling. Well, the sky wasn’t falling and Chicken Little ended up making a fool of himself as well as a lot of his friends.

Sure, state and local governments are suffering greater budget shortfalls. These shortfalls will almost surely result in a few more defaults of outstanding bond issues, but only a very few, and the few that do default will likely be non-investment grade bonds. I will be shocked and surprised if we have a single default in any of the bonds we own in the nine bond portfolios we manage. We are constantly reviewing our holdings in those portfolios, and we are sensitive to trouble when we see it, including the effect of the gulf oil spill on the bonds of Alabama and Mississippi. We have gotten rid of some bonds from time to time when we thought we smelled a rat, and it has paid handsomely. On a number of different occasions we have sold bonds that got into trouble and lost value as a result, but we had already sold them and put the money into something else.

However, it is worth repeating; we are concerned about the budget pressure states and their municipalities are experiencing, and we are watching our holdings closely.

Another subject on which overstatement has become routine is the matter of inflation. The knee-jerk reaction to the large bank bailout that took place about two years ago was “inflation is coming” (the sky is falling?). Today, two years later, inflation approaches 1%, and economists worry more about world-wide deflation. While inflation should cause bond prices to drop, deflation will cause bond prices to rise. We have talked about inflation in almost every letter in the past two years. We don’t believe it will happen anytime soon, and we have said so repeatedly. I am a little tired of worrying about it, and I’ll bet you are too.

Perhaps the newest thing to worry about is the “bond market bubble”. What’s that? Well, I don’t rightly know, but warnings about it appear from time to time in our leading financial publications. I think it is the creation of puzzled pundits trying to explain the rise in prices of U. S. Treasuries in the face of our profligate deficit spending. Logically, these prices should fall. However, this logic doesn’t take into account the profligate spending of most of the Euro-currency countries. Too many foreign investors have decided dollar denominated securities (like U. S. Treasuries) are the safest place to be. I don’t think we have a bond market bubble; instead we have a Euro currency selloff.

There are risks in everything. If you are getting old, like me (I’ll be eighty in July), and pay income tax, I can’t think of a better place to have your money than a tax-free municipal bond fund. The top two marginal tax rates are set to increase in 2011. If you are thirty years younger, what the heck, take some well thought out risks, and live a little. If you are entirely risk adverse by nature, you don’t need to be invested in our funds, you need to be in cash or cash equivalents (money market funds, etc.) and just endure the less than one half percent of interest earned (taxable). Avoiding all risk is expensive in both investment income and lifestyle.

Obviously the above is the advice of an optimist, but not a blind optimist. There are some scary things happening in the financial/political world in Europe as well as here in the United States, so invest with care, but don’t give up.

And with that in mind, let me say that I practice what I preach in all corners of my life. On April 16 past, a year and two months after the death of my wife of a happy 53 years, I married again, this time to my tennis partner of almost fourteen years. I was miserable without a strong feminine presence in my daily life, and Ann Todd provides a lovely antidote. I could have gone on mourning and been miserable, but there is a saying which goes like this. “Life isn’t about waiting for the storm to pass. It’s about learning to dance in the rain.” You can apply that to a lot of things.

Sincerely,

Thomas P. Dupree

President

« Back