Looking Beyond Yield:4 Muni DriversLyle Fitterer, CFA, CPA

FOR INVESTMENT PROFESSIONAL USE ONLY – NOT FOR USE WITH THE RETAIL PUBLIC

Lyle Fitterer, CFA, CPA

Managing Director,Head of Municipal Fixed Income,Co-Head of Global Fixed Income

Meet the expert

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Managing for total return versus yield-first

Defining the four drivers of portfolio management

Why each is critical to evaluation

Key takeaways and next steps

Four drivers of alpha within a muni portfolio

Today’s discussion

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Duration Yield-curve Sectors and credit Security selection

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Oct-07 Oct-09 Oct-11 Oct-13 Oct-15 Oct-17

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Buckeye Tobacco Yale University

Buckeye Tobacco Settlement Bonds

Issued: 10/29/2007

Maturity: 6/01/2047

Coupon: 5.875%

Yield at Issuance: 6.070%

Yale University Bonds

Issued: 10/04/2007

Maturity: 07/01/2042

Coupon: 5.00%

Yield at Issuance: 4.5%

Higher yields have been historically offset by negative price returns

The potential risk of a yield-first focus

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Puerto Rico Commonwealth

Issued: 3/17/2014 Maturity: 7/1/2035 Coupon: 8.00% Yield at Issuance: 8.727%

Credit fundamentals matter along with yield and tax status

Investing for income-only historically has carried risk

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December 2017 Price down almost 80%

Investors often use fixed income for the more conservative portion of their portfolio

Managing for total return offers a less volatile investing experience

We look to participate in strong markets and provide downside protection in weak markets

Managing for total return

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Duration measures the interest-rate sensitivity of a bond or bond portfolio.

The longer a portfolio’s duration, the more sensitive it is to changes in market yields.

Driver #1: Active duration management

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Duration

Lengthen and shorten duration opportunistically

Active duration management

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Maintain the fund’s duration at less than half the benchmark’s duration.

Extend duration at compelling valuations (buy low).

Lock in gains among longer-duration holdings (sell high).

Take advantage of market opportunities

Active duration management

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Long Duration Outperforms Strat Muni - OAD - % of Bench

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Wells Fargo Strategic Municipal Bond Fund’s effective duration to its benchmark, the Bloomberg Barclays Short-Intermediate Municipal Bond Index

Lengthen portfolio duration in advance of a duration rally.

When others engage in panic selling of duration, buy it.

When exuberant buying reduces relative-value opportunities, sell into strength and shorten portfolio duration.

How to apply it

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Duration

Yield-curve positioning refers to the maturity structure of a portfolio and seeks to benefit from changes in the shape of the yield curve.

Driver #2: Yield-curve positioning

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Yield-curve

Match the strategy to the shape of the curve

Yield-curve positioning

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Historical analysis combined with fundamental and technical outlook results in optimal yield-curve positioning.

Yield-curve positioning

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Considerations

Historical slope analysis

Roll down return analysis

Bullet versus barbell maturity structure

Key-rate duration analysis

Current U.S. Treasury vs. sloped muni (10-31-18)

Inverted U.S. Treasury vs. sloped muni (5-15-00)

Flat U.S. Treasury vs. sloped muni (12-27-94)

Conclusions:

Tax-equivalent yield advantage of muni bonds will depend on the shape of both yield curves

Persistent steepness of the muni curve historically rewards marginal maturity extension

Changing relationship of muni to Treasury curves can create interesting opportunities

Yield-curve positioning

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When the curve is expected to flatten, cluster bonds in areas shorter than and longer than the target duration.

The barbell helps whether the short end rises or the long end falls.

When the curve is expected to steepen, build a bullet surrounding the target maturity.

How to apply it

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Yield-curve

Vary sector and credit exposures based on relative-value opportunities.

Driver #3: Allocating across sectors and credit

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Sectors and credit

Look for relative-value opportunities

Allocating across sectors and credit

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Rating Municipal (%) Corporate (%)

AAA 0.00 1.17

AA 0.04 1.48

A 0.17 2.79

BBB 1.07 6.14

BB 5.48 18.46

B 12.38 30.75

CCC/C2 44.88 58.78

Investment-Grade 0.30 3.69

Speculative-Grade 10.37 27.50

Historically, a BBB muni bond has a cumulative default rate less than a AAA corporate bond

Mid-quality credits have outperformed

Allocating across sectors and credit

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Dedicated credit analysis allows active managers to OPPORTUNISTICALLLY MOVE UP AND DOWN credit quality to ADD VALUE for investors.

Calendar year total return by credit tier

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

HY59.97%

HY10.52%

HY8.58%

HY10.74%

AAA3.84%

AAA1.61%

HY32.73%

HY7.80%

A12.53%

HY18.14%

AAA-1.61%

BBB14.47%

BBB4.25%

HY2.99%

HY9.69%

BBB8.35%

BBB8.48%

BBB8.33%

BBB7.60%

AA3.52%

AA-0.76%

BBB26.09%

BBB3.75%

BBB11.84%

BBB9.80%

AA-2.12%

HY13.84%

A3.71%

A0.85%

BBB8.74%

AAA5.37%

A5.35%

A4.02%

A5.26%

A2.67%

A-5.97%

A15.87%

A2.23%

AA10.28%

A8.16%

A-2.56%

A10.52%

AA3.16%

BBB0.35%

A6.16%

AA4.87%

AAA4.21%

AAA3.13%

AA4.66%

HY-2.28%

BBB-21.3%

AA11.72%

AA2.05%

HY9.25%

AA6.23%

HY-5.51%

AA8.22%

AAA2.73%

AA0.05%

AA4.96%

A4.48%

AA3.87%

AA3.09%

AAA4.63%

BBB-2.73%

HY-27.0%

AAA9.06%

AAA2.03%

AAA8.75%

AAA4.52%

BBB-7.17%

AAA6.34%

HY1.81%

AAA-0.17%

AAA4.45%

Rising yields Financial crisis

Crisis recovery PR & Detroit*

Credit recovery, Fed starts hiking*

Opportunity in credit: AAA to BBB spreads

Allocating across sectors and credit

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Municipals (Last 106 bps) Corporates (Last 75 bps)

Municipal Average: 134 bpsCorporate Average: 214 bps

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Credit Outperforms Strategic Municipal Bond Fund - A/BBB/HY/NR Exposure - % of Bench

Allocating across sectors and credit

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Wells Fargo Strategic Municipal Bond Fund credit allocation relative to its benchmark, the Bloomberg Barclays Short-Intermediate Municipal Bond Index

Invest confidently in undervalued, lower-rated munis.

Because the cheapness of lower-rated munis varies across cycles, moving up and down in quality may unlock additional income.

Value can be found by investing in undervalued muni sectors.

How to apply it

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Sectors and credit

Careful security selection is vital to finding relative value and avoiding undue risks.

Driver #4: Selecting securities

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Security selection

Equities Corporate Bonds Muni Bonds

Market Size $50.0 T $7.7 T $3.7 T

Average Daily Volume $76.8 B $19.2 B $6.9 B

Average Daily Number of Trades 9,800,000 37,000 38,000

Average $ per Trade $8,000 $519,000 $161,000

Number of Issuers

Number of CUSIPs

Percent Direct Retail

The muni market is less efficient than other markets

Selecting securities

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1,100,00020,00010,000

5,0005,700

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Credit research uncovers underappreciated risk

Selecting securities

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CT

NJ

ILAK

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IN KS

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MD

MA

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PA

RISC VT

NJ (Approp)

CAME

CO

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Spread in Basis Points

Spread vs. Net Pension Liability per Capita

Likelihood to be compensated for pension risks at current spread levels: More likely Less likely

Pair qualitative and quantitative screens to find securities with attractive risk/reward characteristics.

Assign an internal rating for each security and assess the security’s current price and yield given its inherent risks.

Identify and capture security mis-valuations.

How to apply it

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Security selection

The amount each of the four sources contributes to total return varies over a business cycle

We believe that having an investment process that seeks diversified sources of total return can:

Help mitigate portfolio volatility

Help generate upper-quartile, long-term returns

Key takeaways

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Duration Yield-curve Sectors and credit Security selection

We offer a full lineup across duration and credit

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High Yield Municipal Bond Fund

Municipal Bond Fund

Strategic Municipal Bond Fund

Exposureto credit

Ultra Short-Term Municipal

Income Fund

Short-Term Municipal Bond Fund

Intermediate Tax/AMT-Free

Fund

Duration target

To download a copy of A Four-Source Approach May Reward Investors paper:

Click the resource window on your webinar console

Go to wfam.com/muni

Call us directly at 1-888-877-9275

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wellsfargofunds.com/blog

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Take the next step

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The views expressed and any forward-looking statements are as of 11-16-18 and are those of Portfolio Manager Lyle Fitterer and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.

Mutual fund investing involves risks, including the possible loss of principal. Consult a fund's prospectus for additional information on risks.

Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. For a current prospectus and, if available, a summary prospectus, containing this and other information, visit wellsfargoadvantagefunds.com. Read it carefully before investing.

Wells Fargo Asset Management (WFAM) is the trade name for certain investment advisory/management firms owned by Wells Fargo & Company. These firms include but are not limited to Wells Capital Management Inc. and Wells Fargo Funds Management, LLC. Certain products managed by WFAM entities are distributed by Wells Fargo Funds Distributor, LLC (a broker/dealer and Member FINRA).

This material is for general informational and educational purposes only and is NOT intended to provide investment advice or a recommendation of any kind—including a recommendation for any specific investment, strategy, or plan. 318422 11-18

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FOR INVESTMENT PROFESSIONAL USE ONLY – NOT FOR USE WITH THE RETAIL PUBLIC 30

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