Snapshot: the Us Municipal Bond Market

SNAPSHOT: THE US MUNICIPAL BOND MARKET

WHAT IS A MUNICIPAL BOND?

Municipal bonds are debt instruments issued by states, cities, counties and other governmental entities to finance capital projects that aid a civic purpose, such as the construction of roads, hospitals and schools, or any such infrastructure projects. Municipal bond issuance can be tax exempt or taxable. Tax exempt refers to bonds where interest income is exempted from taxes. Taxable bonds, often of greater interest for international investors, are not tax exempt therefore they tend to offer higher yields.

Foreign investor holdings of US municipal bonds surpassed USD100bn1 for the first time at the end of 2017. The higher yield and strong credit profile of municipal bond issuers attracted foreign investments.

EVOLUTION OF NON-US INVESTOR HOLDINGS MAJOR HOLDERS OF US MUNIS OF MUNIS (USD BN)

120 ■ Individuals ...... 41.00% ■ Mutual Funds ...... 25.00% 100 ■ Banking Institutions ...... 15.00% ■ Insurance Companies ...... 14.00% 80 ■ Other ...... 5.00%

20 Source: SIFMA as of 30 September 2017. 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 ■ MUNIS HOLDINGS (USD BN) Source: Federal Reserve, Moody’s as of 31 December 2017.

1. Source: Federal Reserve, Moody’s as of 31 December 2017. For Financial Professional Use Only / Not for Public Distribution WHY FOREIGN INSTITUTIONAL INVESTORS ARE LOOKING AT THE US MUNICIPAL BOND MARKET

Municipal bonds are commonly used by high net-worth individuals for tax-exempt interest income in the US. Taxable municipal bonds have become increasingly popular among non-US institutional investors, such as insurance companies and pension funds. This shift towards municipal bonds is mainly driven by: 1 ATTRACTIVE YIELDS VERSUS EUROPEAN GOVERNMENT AND CORPORATE DEBT Municipal Bonds exhibit attractive yields compared to European fixed income assets in the long term, even after hedging costs. BBB Taxable AA Taxable Muni Euro AA A Taxable Muni Euro A BBB Taxable Muni Euro BBB Tenure AA Taxable Muni (After Hedge)* Corporates A Taxable Muni (After Hedge)* Corporates Muni (After Hedge)* Corporates Euro Gov 1 Year 1.88 -0.17 -0.26 2.12 0.07 -0.21 2.57 0.52 -0.12 -0.69

3 Year 2.18 0.13 -0.01 2.49 0.44 0.06 3.08 1.03 0.17 -0.47 5 Year 2.59 0.54 0.30 2.88 0.83 0.40 3.51 1.46 0.57 -0.15 10 Year 3.13 1.08 1.00 3.49 1.44 1.16 4.17 2.12 1.44 0.55 15 Year 3.45 1.40 1.48 3.70 1.65 1.62 4.37 2.32 1.92 0.95

20 Year 3.47 1.42 1.70 3.79 1.74 1.85 4.37 2.32 2.14 1.11

Source: Bloomberg, Thomson Reuters TM3 as of 31 December 2017. *Taking into account the annualized euro hedge cost of 205 basis points as of 31 December 2017. Euro Gov Index BS127 Mid Yld EUR Europe Govt Benchmark BVAL Yield Curve 09/29/17 CUSIP. Euro BBB Corporates BS166 Mid Yld EUR Europe Composite BBB+, BBB, BBB- BVAL Yield Curve 09/29/17 CUSIP. Euro A Corporates BS77 Mid Yld EUR Europe Corporate A+, A, A- BVAL Yield Curve 09/29/17 CUSIP. Euro AA Corporates BS165 Mid Yld EUR Europe Corporate AA+, AA, AA- BVAL Yield Curve 09/29/17 Yield. AAA Taxable Muni TM3 MMD Taxable AAA Yield Curve. AA Taxable Muni TM3 MMD Taxable AA Yield Curve. A Taxable Muni TM3 MMD Taxable A Yield Curve. BBB Taxable Muni TM3 MMD Taxable BBB Yield Curve. 2 AVERAGE FINAL MATURITY AT ISSUANCE (YEARS) Municipal bonds show longer average maturity due to the long-term nature of the projects being financed.

10 2010 2011 2012 2013 2014 2015 2016 H1 2017 ■ Munis ■ US Corporates Source: SIFMA as of 30 June 2017. 3 MUNICIPAL BOND CORRELATIONS WITH VARIOUS ASSET CLASSES Municipal taxable bonds may add an additional layer of diversification to fixed income and equity allocations.

0.01 0.7 0.02 0.7 0.5

European European European European Emerging Markets Stocks Corporate Bonds High Yield Government Bonds Hard Currency Bond Source: Five-year correlations, Morningstar Direct as of 31 December 2017. All indices in USD. Taxable Munis are represented by BBgBarc Taxable Municipal TR USD index. European Stocks are represented by FTSE Euro 100 TR USD index. European Government bonds are presented by BBgBarc Euro Agg Treasury TR USD Hedged index. European Corporate bonds are represented by BBgBarc Pan Euro Agg Corp TR USD Hedged index. European High Yield bonds are represented by BBgBarc Pan Euro High Yield TR USD index. Emerging Markets Hard Currency bonds are represented by BBgBarc EM Hard Currency Agg TR USD index.

2 The US Municipal Bond Market For Financial Professional Use Only / Not for Public Distribution 4 CREDIT PROFILE OF MUNICIPAL BONDS Approximately 68% of the muni bond index is rated between AA and AAA, whereas only around 11% of the global corporate index is rated in that range.

60%

45%

30%

15%

0% AAA AA A BAA ■ Municipal Bond Index ■ Global Corporate Index Source: Munis: Barclays Municipal Bond Index: Global Corporate Bonds: Global Aggregate Bond Index – Corporates as of 31 December 2017. 5 MUNICIPAL BONDS DEFAULT RATES Municipals have historically had a very low default rate compared to other fixed income investments. Cumulative default rates; average during 1970–2016; municipals vs. Global Corporates Investment-Grade Speculative-Grade All Rated Municipal Bonds 0.08% 7.52% 0.14%

Global Corporate Bonds 2.38% 29.70% 10.29%

Source: Moody’s as of June 2017.

OPERATIONAL EXPERTISE IN THE MUNICIPAL BOND MARKET

Franklin Templeton has been managing municipal bonds funds for nearly 40 years, utilizing a team of 32 investment professionals which offers, in our view, an expert perspective on the municipal bond market. Today, we’re one of the largest municipal bond fund managers in the world,2 and have more than $71 billion in municipal bond assets under management.3

Our investment approach is grounded on:

FOCUS ON INCOME STRICT INTERNAL CREDIT ANALYSIS Historically, the income return from municipal bonds has We manage credit risks in our municipal bond portfolios contributed significantly more to municipal bonds total by retaining one of the largest, and most well tenured, returns than price appreciation. teams of research analysts in the industry who are responsible of determining the true creditworthiness of PLAIN VANILLA APPROACH municipal issuers. No Leverage, No Derivatives, No Options: we don’t use leverage or invest in derivatives which can increase BUY AND MAINTAIN FOR THE LONG TERM portfolio volatility and expose shareholder capital to Since we are focused on maximizing income, we do not unnecessary risk. actively trade bonds to try to capture capital gains.

2. Source: Strategic Insight, ICI as of 6/30/16. Based on long-term municipal bond fund assets. 3. As of 12/31/16. Municipal bond assets under management figure includes U.S. retail municipal bond fund assets and separately managed accounts.

For Financial Professional Use Only / Not for Public Distribution The US Municipal Bond Market 3 This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal. Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FTI affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. Issued in the U.S. by Franklin Templeton Distributors, Inc., One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Templeton Distributors, Inc. is the principal distributor of Franklin Templeton Investments’ U.S. registered products, which are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

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