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 2.66% in the first quarter versus a return of 2.74% for the benchmark S&P Municipal Bond Intermediate Index.
The Fund’s option-adjusted duration (OAD) ended the first quarter at 5.12 years. The Fund is positioned 0.01 years short of the benchmark S&P Municipal Bond Intermediate Index OAD of 5.11 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 1 basis point (bps) ending the quarter at 48 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 75.98% exposure and the Index has 28.17% exposure in these categories.
The Fund continues to overweight to the Hospital, Higher Education, Housing, Public Power, and Airport sectors relative to its benchmark. It is underweight to the state General Obligation, local General Obligation, and Appropriation sectors.
Municipal Market Review
The municipal market showed impressive performance in the first quarter, with the S&P Municipal Bond Index generating a return of 2.76%. The market sprinted to the finish line, with approximately one-third of the total return generated in the last two weeks of March. Municipal yields moved lower throughout the quarter and accelerated downward after the March 20 Federal Open Market Committee (FOMC) meeting. The relative strength in the muni market, driven largely by supply and demand factors, further supplemented price performance. The municipal yield curve flattened, as measured from the 2- and 30 year rates. The municipal 2-year rate declined by 29 basis points (bps) and the 30-year rate declined by a strong 42 bps in the quarter, resulting in the curve flattening.
The flattening of the curve in the first quarter was observable in the return differentials, with longer-term bonds outpacing shorter ones. Rates declined significantly across the term structure. Consequently, portfolios biased toward greater interest-rate sensitivity easily outperformed those carrying shorter durations. Yield ratios of 10-year AAA municipals relative to US Treasuries moved sharply lower in the quarter to 0.77 from 0.85, driven by strong technical factors within the municipal market. At the current ratio, municipals are the richest they have been to Treasuries since 2010.
After four policy rate moves in 2018, the FOMC has declined to take action on rates at two meetings thus far in 2019. The policy rate remains at a target of 2.25% to 2.50%. Following its March 20 meeting, the FOMC softened its stance on economic growth prospects. The market has followed suit and begun to contemplate the potential of current target rates at the cyclical peak.
During the first quarter, municipal bond mutual funds experienced the strongest net inflows since such data collection began in 1992. Through March 20, municipal bond mutual funds received $23.7 billion worth of net inflows, averaging roughly $1.97 billion per week. Weekly inflows were greater than $2.0 billion for half of the quarter and peaked at $3.3 billion during the first week of February. Some have attributed the surge in inflows to certain high rate taxpayers seeking substitutions for the newly curtailed state and local tax (SALT) deduction. The unprecedented strength of inflows contributed to the aforementioned relative strength the municipal market has enjoyed in the new year.
Issuance activity in the first quarter of the year accelerated by 14.4%, or $9.4 billion, compared to a historically weak first quarter in 2018 when the market was digesting the implementation of the Tax Cuts and Jobs Act (TCJA).
Municipal credit performance added to returns in the first quarter. Relatively positive news from Puerto Rico’s restructuring spurred confidence among investors in lower quality debt. The rising tide from Puerto Rico, combined with a very favorable technical environment, also brought a stronger bid to investment grade bonds.
After a very strong fourth quarter of 2018, the municipal market followed with an encore performance in the first quarter. Accordingly, total returns favored longer-duration portfolios and lower credit quality portfolios. The Fed softened its stance on the economy in the first leg of 2019, which may portend economic weakness and the possibility of rate cuts as the year proceeds. While the total return backdrop appears favorable for the municipal sector for the remainder of the year, we would not be surprised if returns were flat to negative for 2Q19.