short duration government bond fund report · seeks to outperform the bloomberg barclays 1–3 year...

Quarterly Report Q1 2018 | All information is as of 3/31/2018 unless otherwise indicated.

Ticker: WSGIXPortfolio managers: Thomas O'Connor, CFA; Troy Ludgood; Maulik Bhansali, CFA; and Jarad VasquezSubadvisor: Wells Capital Management Inc.Category: Short-term bond

■ Seeks to outperform the Bloomberg Barclays 1–3 Year Government Bond Index by investing themajority of its assets in high-quality securities issued or guaranteed by U.S. government agencies orgovernment-sponsored enterprises

■ Typically maintains a duration neutral to that of the benchmark, with a predominant emphasis onbottom-up security selection among a universe of high-quality, liquid bonds

■ Uses proprietary risk management systems as the foundation for a highly disciplined decision-makingprocess

1.220.530.400.02-0.15-0.15Bloomberg Barclays 1-3 YearGovernment Index

1.030.230.210.03-0.19-0.19Lipper Short U.S.Government Funds Average

4.122.120.650.580.27-0.14-0.14Short Duration GovernmentBond Fund-Inst

Since inception(12/18/92)10 year5 year3 year1 year

Year todate3 month

*Returns for periods of less than one year are not annualized.

Figures quoted represent past performance, which is no guarantee of future results, and do not reflect taxes ashareholder may pay on a fund. Investment return, principal value, and yields of an investment will fluctuate so that aninvestor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower orhigher than the performance data quoted and assumes the reinvestment of dividends and capital gains. Current month-endperformance is available at the fund’s website, wellsfargofunds.com. Institutional Class shares are sold without a front-endsales charge or contingent deferred sales charge.

The fund’s gross expense ratio is 0.46%. The fund’s net expense ratio is 0.42%. The manager has contractuallycommitted, through December 31, 2018, to waive fees and/or reimburse expenses to the extent necessary to capthe fund’s total annual fund operating expenses after fee waivers at 0.42% for the Institutional Class. Brokeragecommissions, stamp duty fees, interest, taxes, acquired fund fees and expenses (if any), and extraordinaryexpenses are excluded from the cap. After this time, the cap may be increased or the commitment to maintain thecap may be terminated only with the approval of the Board of Trustees. Without this cap, the fund’s returns wouldhave been lower. The expense ratio paid by an investor is the net expense ratio (the total annual fund operatingexpenses after fee waivers) as stated in the prospectus.

■ Bond yields rose amid a better economic outlook. Labor marketscontinued to tighten, and inflation expectations rose.

■ The fund performed in line with its benchmark, the BloombergBarclays 1-3 Year Government Index, with sector allocations andissue selection being the most significant drivers of return.

Alongside a strengthening economic outlook, the U.S. Federal Reserve(Fed)—now headed by Chair Jerome Powell—raised the target range forthe federal funds rate to between 1.50% and 1.75%. In addition, theFed’s balance sheet declined by $20 billion per month, with $12 billion inTreasuries and $8 billion in mortgage-backed securities (MBS) not beingreinvested. A new tax law passed in December 2017 fueled expectationsfor better growth and higher inflation in 2018. Meanwhile, the impositionof steel tariffs by the U.S. sparked fears of a trade war. Finally, equitymarket volatility returned in 2018 after a period of relative steadiness, andfixed-income markets experienced some risk-off sentiment as well.

In the markets, U.S. Treasury yields increased about 33 basis points(bps; 100 bps equal 1.00%) during the first quarter, largely as the resultof the tighter monetary policy, better-than-expected global growth, thelikelihood of a growing federal deficit, and signs of an uptick in inflation.The yield curve continued its flattening trend as longer-term yields roseless than shorter-term yields. In terms of performance, shorter-term debtoutperformed longer-term debt.

Fixed-income sectors were not immune to equity market volatility. After astrong January, structured products sold off in February and March toend the quarter between 5 bps and 10 bps wider due to general risk-offsentiment, more new-issue supply, and wider swap spreads. Investment-grade credit spreads also widened during the quarter, despite reaching apostcrisis tight in early February, due to higher interest rates and aweaker supply/demand balance (especially as rising hedging costs muteddemand from foreign investors).

(See pages 4–5 for important information.)

1 CM213 04-18 Wells Fargo Short Duration Government Bond Fund

Quarterly Report Q1 2018

■ The fund maintained a neutral duration according to its mandate. While we may purchase securities longer than the benchmark’s duration of 1.9 years, we expect to maintain aneffective duration that is within 10% of the benchmark.

■ As the U.S. economy continues to show signs of strength, we expect the Federal Open Market Committee (FOMC) to raise its target range for the federal funds rate two or threemore times in 2018. We will continue to target a neutral duration through security selection between government debt and nongovernment securitized allocations.

■ The fund’s yield-curve positioning is the result of individual security choices rather than a top-down decision. During the quarter, the fund had allocations to points further out theyield curve than the benchmark, which was a small negative. The fund tactically uses 2-, 5-, and 10-year U.S. Treasury futures to neutralize overall curve exposure.

■ The yield curve steepened early in the quarter, but as the quarter went on, interest rates rose and the curve flattened. As the FOMC continues to raise interest rates on the shortend of the curve, we expect the curve to further flatten but not invert.

■ The fund has maintained a consistent underweight to U.S. Treasury and agency debt and overweights to out-of-benchmark securitized allocations in mortgages, asset-backedsecurities (ABS), and commercial mortgage-backed securities (CMBS). In mortgage pass-throughs, our exposure was unchanged throughout the quarter, and this positioningdetracted from performance as interest rates rose and volatility increased in the mortgage market. ABS remained our highest-conviction sector, and the overweight detractedduring the quarter.

■ Within our sector allocations, we remain overweight mortgages, ABS, and CMBS and underweight agencies and Treasuries. Throughout the quarter, driven by bottom-up secu-rity selection, we maintained an overweight to longer-duration risk and an underweight to two-year risk versus the benchmark.

■ The fund’s positioning is maintained at the highest quality of AAA-rated, the same as the benchmark.■ Within the highly rated credit tiers of the short-term government universe, AA-rated credits returned -0.05%, outperforming higher-quality AAA-rated debt that underperformed

due to weakness in short-term Treasuries.

■ Security selection in agency MBS pools helped results because positions in higher coupon pools performed well. We also avoided lower-coupon pools and Ginnie Mae mort-gages, which underperformed amid the higher volatility during the quarter. Issue selection within ABS continued to be a positive contributor, particularly from Federal FamilyEducation Loan Program (FFELP) student loan issues.

■ During the quarter, our allocation to various parts of the mortgage market was unchanged as we remained patient for securities to reach our valuation targets. In the non-government portion of the fund’s strategy, we modestly reduced our ABS and CMBS exposures as we realized value on auto finance deals and maintained the rest of our ABSposition in student loans, auto fleets, and rental cars.

■ We remain constructive on ABS and CMBS and seek to selectively add allocations on security mispricings. As the Fed unwinds its accommodative monetary policy, this couldlead to further volatility in fixed-income markets, and we remain opportunistic in the mortgage pass-through space.

*Performance attribution is discussed gross of expenses. The gross-of-expenses performance attribution does not reflect the deduction of the fund’s expenses as shown in the prospectus.

2 Wells Fargo Short Duration Government Bond Fund


1.92%30-day SEC yield

1.9910.91Avg. maturity (yrs.)

1.932.08Avg. eff. duration

Bloomberg Barclays1-3 Year Government

Index

Wells FargoShort Duration

Government BondFund

0.00-0.50Cash & equivalents

3.331.73AA/Aa

96.6798.77AAA/Aaa

0.00-0.50Cash & equivalents

0.0014.81ABS

0.007.63CMO

0.0037.31MBS

0.002.27CMBS

7.311.73Government-related

92.6936.60U.S. treasuries

1. The ratings indicated are from Standard & Poor's, Fitch Ratings, and/or Moody's Investors Service.The percentages of the fund’s portfolio with the ratings depicted in the chart are calculated based onthe total investments of the fund. If a security was rated by all three rating agencies, the median ratingwas used. If a security was rated by two of the three rating agencies, the lower rating was used. If asecurity was rated by one of the agencies, that rating was used. Portfolio characteristics, sectorweights, and allocations are subject to change and may have changed since the date specified. Due torounding, percentages may not add up to 100%.

The fund's 30-day unsubsidized SEC yield is 1.87%.

$688.82MAssets—all share classes0.42%Net expense ratio—Inst12/18/92Inception date

Morningstar total return rankings—Institutional Class (as of 3/31/18)

117 out of 25510 year




Short-term bondMorningstar Category

Overall Morningstar Rating ™ ★★★

The Overall Morningstar Rating, a weighted average of the 3-, 5-, and 10-year (if applicable)ratings, is out of 455 funds in the Short-term bond category, based on risk-adjusted returns asof 3/31/18.

12/31/180.370.41MSDRXR6

12/31/180.420.46WSGIXInst

12/31/180.600.73MNSGXAdmin

12/31/181.531.54MSDCXC

12/31/180.780.79MSDAXA

Contractual expensewaiver date

Net expense ratio(%)

Gross expense ratio(%)

TickerShareclass

The manager has contractually committed to waive fees and/or reimburse expenses to theextent necessary to cap the fund’s total annual fund operating expenses after fee waivers at0.78% (A), 1.53% (C), 0.60% (Admin), 0.42% (Inst), and 0.37% (R6). Brokerage commissions,stamp duty fees, interest, taxes, acquired fund fees and expenses (if any), and extraordinaryexpenses are excluded from the cap. After this time, the cap may be increased or thecommitment to maintain the cap may be terminated only with the approval of the Board ofTrustees. Without this cap, the fund’s returns would have been lower. The expense ratio paid byan investor is the net expense ratio (the total annual fund operating expenses after fee waivers)as stated in the prospectus.



Benchmark descriptions:

The Bloomberg Barclays 1–3 Year Government Bond Index is composed of all publicly issued,nonconvertible domestic debt of the U.S. government and its agencies. The index also includescorporate debt guaranteed by the U.S. government. Only notes and bonds with a minimum maturity of1 year up to a maximum maturity of 2.9 years are included. You cannot invest directly in an index.

The Lipper averages are compiled by Lipper, Inc., an independent mutual fund research and ratingservice. Each Lipper average represents a universe of funds that are similar in investment objective.You cannot invest directly in a Lipper average.

Definition of terms:

30-day SEC yield: The 30-day SEC yield is calculated with a standardized formula mandated by theSEC. The formula is based on maximum offering price per share and includes the effect of any feewaivers. Without waivers, yields would be reduced. The 30-day unsubsidized SEC yield does notreflect waivers in effect. A fund's actual distribution rate will differ from the SEC yield, and any incomedistributions from the fund may be higher or lower than the SEC yield.

Credit-quality ratings: Credit-quality ratings apply to underlying holdings of the fund and not the funditself. Standard & Poor's and Fitch rate the creditworthiness of bonds from AAA (highest) to D (lowest).Standard & Poor's rates the creditworthiness of short-term notes from SP-1 (highest) to SP-3 (lowest).Ratings from A to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relativestanding within the rating categories. Moody’s rates the creditworthiness of bonds from Aaa (highest) toCC (lowest). Ratings Aa to B may be modified by the addition of a number 1 (highest) to 3 (lowest) toshow relative standing within the ratings categories. Moody’s rates the creditworthiness of short-termU.S. tax-exempt municipal securities from MIG-1/VMIG-1 (highest) to SG (lowest). Credit quality andcredit-quality ratings are subject to change.

Duration: Duration is the weighted average of the timing of cash-flow payments from fixed incomesecurities. Duration is used as a measurement of sensitivity to interest rates.

Yield curve: The yield curve is a graphical representation of fixed-income security yields (usually U.S.Treasuries) at their respective maturities, starting with the shortest time to maturity and sequentiallyplotting in a line chart to the longest maturity.

The Morningstar Rating for funds, or star rating, is calculated for managed products (including mutualfunds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, andseparate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutualfunds are considered a single population for comparative purposes. It is calculated based on aMorningstar risk-adjusted return measure that accounts for variation in a managed product's monthlyexcess performance, placing more emphasis on downward variations and rewarding consistentperformance. The Morningstar Rating does not include any adjustment for sales loads. The top 10% ofproducts in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35%receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The OverallMorningstar Rating for a managed product is derived from a weighted average of the performancefigures associated with its 3-, 5-, and 10-year (if applicable) Morningstar Rating metrics. The weightsare: 100% 3-year rating for 36–59 months of total returns, 60% 5-year rating/40% 3-year rating for60–119 months of total returns, and 50% 10-year rating/30% 5-year rating/20% 3-year rating for 120 ormore months of total returns. While the 10-year overall star rating formula seems to give the mostweight to the 10-year period, the most recent 3-year period actually has the greatest impact because itis included in all three rating periods. Across U.S.-domiciled short-term bond funds, the Short DurationGovernment Bond Fund received 2 stars among 455 funds, 2 stars among 393 funds, and 3 starsamong 255 funds for the 3-, 5-, and 10-year periods, respectively. The Morningstar Rating is for theInstitutional Class only; other classes may have different performance characteristics.

Past performance is no guarantee of future results.



Risks: Bond values fluctuate in response to the financial condition of individualissuers, general market and economic conditions, and changes in interest rates.Changes in market conditions and government policies may lead to periods ofheightened volatility in the bond market and reduced liquidity for certain bondsheld by the fund. In general, when interest rates rise, bond values fall andinvestors may lose principal value. Interest-rate changes and their impact on thefund and its share price can be sudden and unpredictable. Securities issued byU.S. government agencies or government-sponsored entities may not beguaranteed by the U.S. Treasury. Certain investment strategies tend to increasethe total risk of an investment (relative to the broader market). This fund isexposed to mortgage- and asset-backed securities risk. Consult the fund’sprospectus for additional information on these and other risks. The U.S.government guarantee applies to certain underlying securities and not to sharesof the fund.

The views expressed in this document are as of March 31, 2018, and are those of the portfoliomanager(s). The views are subject to change at any time in response to changing circumstances in themarket and are not intended to predict or guarantee the future performance of any individual security,market sector or the markets generally, or any Wells Fargo Fund. Any specific securities discussedmay or may not be current or future holdings of the fund. The securities discussed should not beconsidered recommendations to purchase or sell a particular security. Wells Fargo FundsManagement, LLC, disclaims any obligation to publicly update or revise any views expressed orforward-looking statements.

Carefully consider a fund’s investment objectives, risks, charges, and expenses beforeinvesting. For a current prospectus and, if available, a summary prospectus, containingthis and other information, visit wellsfargofunds.com. Read it carefully before investing.Wells Fargo Asset Management (WFAM) is a trade name used by the asset managementbusinesses of Wells Fargo & Company. Wells Fargo Funds Management, LLC, a wholly ownedsubsidiary of Wells Fargo & Company, provides investment advisory and administrative servicesfor Wells Fargo Funds. Other affiliates of Wells Fargo & Company provide subadvisory andother services for the funds. The funds are distributed by Wells Fargo Funds Distributor, LLC,Member FINRA, an affiliate of Wells Fargo & Company. Neither Wells Fargo Funds Distributornor Wells Fargo Funds Management holds fund shareholder accounts or assets. This materialis for general informational and educational purposes only and is NOT intended to provideinvestment advice or a recommendation of any kind—including a recommendation for anyspecific investment, strategy, or plan. 311558


NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

CM213 04-18

short duration government bond fund report · seeks to outperform the bloomberg barclays 1–3 year...

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