On the credit front, total returns for AAA- through BBB-rated securities ended the year virtually the same.

Credit spreads barely budged despite growing fundamental uncertainties wrought by tariff policy, the One Big Beautiful Bill Act (OBBBA), and the public discourse over the next Federal Reserve (Fed) chair. Even a two-day, 50% collapse of a municipal high-yield fund during the summer, and the precipitous fall of certain Brightline railroad bonds into the $30 range a few months after that, had little impact. Still a fledgling operation, Brightline’s ridership has fallen woefully short of their forecasts. We do not speculate on projects and instead rely on proven revenues and robust support mechanisms to help avoid situations like this.

On the supply front, new issuance surged to a new record in 2025. At $575 billion, supply surpassed 2024’s then-record by 15%, with school funding accounting for the vast majority of the year-over-year increase. Investors easily absorbed the year’s new issuance. Two notable exceptions were the failed placements of a large tire recycling plant in Oklahoma and a casino in New York. We view the ultimate purpose of a bond issuance as an important component of credit criteria. As we prefer to invest in bonds that fund essential services or critical infrastructure, those deals failed our basic test.

We seek to own securities that possess durability – meaning resilience to a wide range of economic and political conditions, both nationally and locally. Historically, we have viewed federal aid as a stabilizing force for municipal credit, but over the last year, it has become a source of uncertainty. The federal government has signaled an intent to shift funding burdens onto state and local governments. One of the primary catalysts of this funding shift is the OBBBA, which was passed in July and brought sweeping tax and policy changes.

The OBBBA includes Medicaid cuts of $900 billion, with significant changes to enrollment eligibility beginning in 2027. States receive roughly one-third of their funding from federal aid. Medicaid comprises nearly 70% of that aid, and the rest is split across education, infrastructure, and social assistance, among other areas. We expect most state credits to remain strong, but hospitals will face larger challenges. The year-end expiration of Affordable Care Act enhanced tax credits could leave millions uninsured. This, along with lower reimbursement rates and supplemental funding, poses more immediate risks. In addition, we anticipate changes in the transportation, higher education, and housing sectors. We note that many of these funding cuts are not currently priced into market valuations, and we did not expect such drastic cuts.

On a local level, in November 2025, Zohran Mamdani was elected as the new mayor of New York City. The city’s $120 billion budget is larger than those of all states except California, Texas, and New York itself. Many have asked whether Mayor Mamdani can accomplish his wide-ranging agenda. We think he will face constraints. The mayor does not control the city’s tax rates nor its debt limit. The mayor also cannot change bus fares (which are within the purview of the Metropolitan Transportation Authority [MTA], a public benefit corporation of the state) or the minimum wage (which is set under state law). On the other hand, the mayor can propose a budget to be approved by the city council; veto city laws; hire and fire agency heads and commissioners, such as members of the Rent Guidelines Board; and appoint city judges. However, exercising these powers can take time, and change will not occur overnight.

The extended federal government shutdown in Q4 2025 and the interruption of critical economic statistical releases added to an already eventful 2025. This no doubt hindered the effectiveness of the Fed’s crystal ball. Data dependency requires data, after all. Despite persistent inflation above its 2% target, the Fed shifted its attention to labor market conditions. Characterizing the labor market as “weakening” or “normalizing” from very strong levels is a matter of political preference. Nevertheless, the Fed has now eased interest rates for three Federal Open Market Committee (FOMC) meetings in a row, but it is anyone’s guess where the federal funds rate will end this year. There is an unusually wide range of views within the Fed itself, ranging from six rate cuts to two rate hikes for this year. One thing is for certain; the Fed will get a new chair in May 2026, one who the White House believes will try to move aggressively on rates. This is an important factor underpinning our recommendation to extend out of cash and reserves to lock in today’s attractive intermediate- and longer-maturity yields.

Although longer bonds continued their comeback during fourth quarter 2025, they still lagged significantly for the year. We gradually leaned into this weakness, adding larger positions of longer bonds (15- to 20-year maturities), given their substantial excess yield and roll-down potential. Short-maturity bonds reflect expectations of aggressive Fed easing, limiting their potential returns. We are proud of the results we generated through a year in which the market behaved aberrantly, from extreme volatility to extreme stability. For the fourth quarter, we generated a return of about 1.5% for our intermediate portfolios, bringing their calendar year return to 5.7%. We closed the quarter 52 bps ahead of the index, bringing our full-year excess returns to +58 bps.

Despite unprecedented market stability during the quarter, we added several attractive opportunities. Within the prepaid gas/energy sector, we purchased a five-year obligation guaranteed by JP Morgan (JPM) at a spread of 100 bps. This was the first JPM-backed issuance since 2012. We also participated in a transaction backed by American National Insurance Company (ANICO), with an eight-year maturity, at a spread of 175 bps. Although this was ANICO’s first entry into the municipal market, the credit is well known to our taxable fixed income team. Within the housing sector, we added a range of planned amortization class (PAC) bonds as well as Freddie Mac-backed bonds with spreads in the range of 110 to 125 bps. We also purchased longer-maturity New York City Transitional Finance Authority bonds with spreads in the 50-bp range. This is roughly 15 to 20 bps more than we believe is warranted for this strong credit. Furthermore, these bonds offer attractive roll-down, which enhances their expected returns. We expect Q4’s additions, together with securities we added earlier in 2025, to provide benefits for years to come.

Looking ahead, how’s it going to be? Only time will tell, but we would not believe anyone who claims to know. Our investment process and research will help us seize opportunities and guard against the inevitable risks we will face. We are excited about the year ahead and look forward to hitting the ground running in 2026!

We hope you enjoyed a healthy and happy holiday season and appreciate the trust you have placed in us.