Past performance is no guarantee of future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here.
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The views expressed in this investment report represent the opinions of PNC Capital Advisors, LLC and are not intended to predict or depict performance of any investment. All information contained herein is for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation or recommendation to purchase any security. The information herein was obtained by various sources; we do not guarantee its accuracy or completeness. Fund performance quoted above is for class I shares. Past performance does not guarantee future results. These views are as of the date of this publication and are subject to change based on subsequent developments.
An investment in the Fund is subject to interest rate risk, which is the possibility that a Fund's yield will decline due to falling interest rates and the potential for bond prices to fall as interest rates rise. For some investors, income may be subject to state and/or local taxes, and certain investors may be subject to the federal Alternative Minimum Tax (AMT). Economic or political changes may impact the ability of municipal issuers to repay principal and interest payments on securities of the Fund, which may adversely impact the Fund’s shares. The Fund may be subject to call risk, which is the risk of a bond being called prior to maturity. The Fund may be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.
PNC Intermediate Tax Exempt Bond (class I) returned 1.97% in the second quarter versus a return of 2.05% for the benchmark S&P Municipal Bond Intermediate Index.
The Fund’s option-adjusted duration (OAD) ended the second quarter at 4.99 years. The Fund is positioned 0.03 years long of the benchmark S&P Municipal Bond Intermediate Index OAD of 4.96 years.
Credit spreads on municipal bonds, as measured by the option-adjusted spread (OAS) of the S&P Municipal Bond Intermediate Index, moved lower by 3 basis point (bps) ending the quarter at 45 bps. (One basis point is equal to 0.01%, or 1/100th of a percent). The Fund’s exposure to mid- (A) and low-grade (BBB) credit is overweight, as the Fund has 76.77% exposure and the Index has 28.24% exposure in these categories.
The Fund is overweight to the Airport, Higher Education, Hospital, Tollroads, and Housing sectors relative to its benchmark. It is underweight to the state General Obligation, local General Obligation, and Dedicated Tax sectors.
Municipal Market Review
During the second quarter, the municipal market provided an encore to first quarter’s impressive performance, with the S&P Municipal Bond Index producing a return of 2.12%. For the year, the Index has logged a 4.94% total return. While absolute returns were strong, the municipal market underperformed U.S. Treasuries for the quarter. The municipal yield curve continued its flattening trend, as measured by the spread between 2- and 30-year rates. However, the curve shift was less pronounced this quarter, as the 2-year rate declined by 24 basis points (bps) and the 30-year rate declined by 29 bps.
Yield ratios of 10-year AAA municipals relative to U.S. Treasuries retraced a portion of the sharp downward move in the first quarter, increasing to 81% from 77%. The ratio at the end of the first quarter marked a historical low not seen since 2010.
The Federal Reserve policy rate may have reached its cyclical peak for this cycle at the current range of 2.25% to 2.50%. After four policy rate increases in 2018, the rate has remained steady through four meetings in 2019, including two during the second quarter. At its June 19 meeting, the Federal Open Market Committee (FOMC) confirmed the market’s view by signaling a new bias toward rate cuts going forward. Municipal short-term rates appeared to wholly ignore the Fed over the entirety of the quarter, as the SIFMA Municipal Swap Index Yield (SIFMA) began the period at 1.50% and ended at 1.90%. However, it is worth noting, SIFMA experienced substantial volatility throughout the quarter, as it ranged from 1.32% to 2.30%, even as the Fed took no action on its policy rate.
Issuance activity in the second quarter declined by 11.4% compared to a strong second quarter in 2018 when the market had fully adjusted to the changes caused by the Tax Cuts and Jobs Act (TCJA), which was enacted in December 2017. Total volume for second quarter 2019 was $88.7 billion through 2,861 issues, compared to $100.1 billion through 2,923 issues in the year-ago period.
Municipal credit spreads blazed new territory in the quarter, reaching new post-financial-crisis lows. Consequently, credit spread tightening, particularly among A- and BBB-rated bonds, supplemented positive total returns. Perceptions of stabilizing credit quality among some of the weaker states ostensibly provided comfort to credit investors. Additionally, an ongoing favorable technical environment enticed buyers to higher-yielding instruments. As a result, relatively lower-quality portfolios outperformed over the period; 10-year credit spreads for A-rated and BBB-rated bonds tightened by 3 bps and 8 bps, respectively. Both credit categories ended the quarter at new post-crisis spread lows: 33 bps for A-rated and 67 bps for BBB-rated.
The municipal market posted strong positive returns across the indices in the second quarter, following a similar path from the first three months of the year. Declining rates and spread tightening drove performance. The Fed signaled a new bias toward rate cuts, aligning itself with the market view from the prior quarter. While the FOMC report was generally upbeat on the economy, the newly accommodative stance could signify a growing prospect of economic vulnerabilities in the second half of the year. Many market participants believe at least one rate cut is forthcoming in 2019. Low absolute yields in the municipal market will continue to struggle with very positive technical factors to decide the future direction of interest rates. In our view, the market is highly dependent on the durability of the favorable technical environment to sustain current elevated valuations. Therefore, we believe the market is vulnerable to downside risk and it is unlikely that the second half of the year can retain the entirety of the current positive price trend thus far.