May 5, 2017
Dear fellow shareholder,
During its 29 years of operations, the Hawaii Municipal Fund (the “Fund”) has provided shareholders with the opportunity to earn double tax-free income* while supporting local projects designed to enrich the community. These projects may include improvements to schools, roads, utility systems, hospitals, housing and other projects that help to improve the quality of life here in Hawaii.
According to the Hawaii Department of Business, Economic Development & Tourism (“DBEDT”), Hawaii’s economy is expected to continue positive growth. DBEDT reported that the 2016 economic growth rate was 2 percent, and forecasts that the rate will be 1.8 percent in 2017. This outlook is based on the performance of Hawaii’s tourism industry, labor market conditions and the growth of tax revenues, however there remains the potential downside impact from unexpected matters such as geopolitical issues and U.S. government policy changes that may affect this forecast.
Interest rates are one of the most important of many factors which can affect bond prices. On March 15, 2017, the Federal Open Market Committee (“FOMC”) increased the federal funds rate to a target range of 0.75 percent to 1.00 percent, its third increase since tightening began in December 2015. The FOMC acknowledged that economic activity has continued to expand at a moderate pace citing continued improvement in the labor market as job gains remained solid and the unemployment rate was little changed. The FOMC expects that with gradual adjustments in the stance of monetary policy, that inflation will stabilize around 2 percent over the medium term and that economic activity will continue to expand at a moderate pace.
The Fund had a beginning net asset value (“NAV”) of $11.36 per share on October 1, 2016 and a closing NAV of $11.02 per share on March 31, 2017. The Fund’s $0.34 per share decrease in NAV combined with the net income distribution of $0.13 per share resulted in a total return of -1.85%1 for the six month reporting period ended March 31, 2017. During the same period, the return for the Fund’s benchmark index, the Bloomberg Barclays Municipal Bond Index, was -2.10%1. The Fund’s portfolio manager will continue to evaluate potential and current portfolio holdings believed to provide an advantageous combination of yield, quality and maturity. We continue to believe that municipal bonds are attractive investments for long term investors.
Thank you for your continued support and referrals. On the following pages you will find our March 31, 2017 Semi-Annual Report. If you have any questions or would like us to provide information about the Fund to your family or friends, please call us at (808) 988-8088.
Warmest Aloha,
Terrence K.H. Lee
President and CEO
| * | Some income may be subject to the federal alternative minimum tax for certain investors. Income may also be subject to capital gains taxes. |
1 | Return is not annualized. |
Before investing, read the prospectus carefully. Please carefully consider the Fund’s investment objective, risks, and charges and expenses before investing. The prospectus contains this and other information about the Fund. This Semi-Annual Report must be accompanied or preceded by a prospectus.
A word about risk: Mutual fund investing includes risks. Principal loss is possible. The Fund’s investments in municipal bonds subjects the Fund to interest rate, credit, call and geographic concentration risk. This is not a complete list of risks that may affect the Fund. For additional information concerning the risks applicable to the Fund, please see the Fund’s prospectus. Performance quoted represents past performance. Past performance is no guarantee of future results. The Fund’s yield, share price and investment return fluctuate so that you may receive more or less than your original investment upon redemption.
The Bloomberg Barclays Municipal Bond Index consists of a broad selection of investment grade general obligation and revenue bonds of maturities ranging from one year to 30 years. It is an unmanaged index representative of the tax-exempt bond market. This index is made up of all investment grade municipal bonds issued after December 31, 1990 having a remaining maturity of at least one year. It is not possible to invest directly in an unmanaged index.
The Hawaii Municipal Fund is a series of Lee Financial Mutual Fund, Inc. Lee Financial Securities, Inc., member FINRA, is the distributor for Lee Financial Mutual Fund, Inc. Lee Financial Securities, Inc. is a wholly owned subsidiary of Lee Financial Group Hawaii, Inc., a registered investment advisor with the SEC.
This report may contain certain forward-looking statements about factors that may affect the performance of the Fund in the future. These statements are based on the predictions and expectations of Lee Financial Group Hawaii, Inc., the Fund’s investment manager, (the “Investment Manager”), concerning certain future events, such as performance of the economy, changes in interest rates and other factors that may impact the performance of the Fund. The Investment Manager believes that these forward looking statements are reasonable, although they are inherently uncertain and difficult to predict. Actual events may cause adjustments in portfolio management strategies from those currently expected to be employed.
YOUR FUND’S EXPENSES
As a Fund shareholder, you can incur the following costs:
| • | Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. |
The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated.
Actual Fund Expenses
The first line (Actual) for the share class listed in the table below provides actual account values and expenses. The “Ending Account Value” is derived from the Fund’s actual return, which includes the effect of Fund expenses.
You can estimate the expenses you paid during the period, by following these steps. Of course, your account value and expenses will differ from those in this illustration:
| 1. | Divide your account value by $1,000. If an account had an $8,600 value, the $8,600 ÷ $1,000 = 8.6. |
| 2. | Multiply the result by the number under the heading “Expenses Paid During Period.” If Expenses Paid During Period were $7.50, then 8.6 x $7.50 = $64.50. |
In this illustration, the estimated expenses paid this period are $64.50.
Hypothetical Example for Comparison with Other Funds
Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical “Ending Account Value” is based on the actual expense ratio for the share class and an assumed 5% annual rate of return before expenses, which does not represent the Fund’s actual return. The figure under the heading “Expenses Paid During Period” shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds.
Please note that expenses shown in the table are meant to highlight ongoing costs.Therefore, the second line is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. Please refer to the Fund prospectus for additional information on operating expenses.
| | Beginning Account Value 10/01/2016 | Ending Account Value 03/31/2017 | Expenses Paid During Period* 10/01/16 – 03/31/17 |
| Hawaii Municipal Fund Investor Class | | | |
| Actual | $1,000.00 | $981.50 | $5.31 |
| Hypothetical | $1,000.00 | $1,019.57 | $5.41 |
* | Expenses are equal to the annualized expense ratio (1.07%), multiplied by the average account value over the period, multiplied by 182/365 to reflect the one-half year period. |
See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
At March 31, 2017, unrealized appreciation (depreciation) of securities for federal income tax purposes is as follows:
See accompanying notes to financial statements.
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS
March 31, 2017 (Unaudited)
| (1) | ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Hawaii Municipal Fund (“Fund”) is a series of Lee Financial Mutual Fund, Inc. which is registered under the Investment Company Act of 1940, as a non-diversified open-end management investment company. Lee Financial Mutual Fund, Inc. currently has one investment portfolio, the Fund which is currently offering one Class of Shares: Investor Shares.
The investment objective of the Fund is to provide a high level of current income exempt from federal and Hawaii state income taxes, consistent with preservation of capital and prudent investment management. The Fund seeks to achieve its objective by investing primarily in a portfolio of investment grade municipal securities issued by or on behalf of the State of Hawaii, or any of its political subdivisions, which pay interest that is exempt from regular federal and Hawaii income taxes.
The Fund is subject to the risk of price fluctuation of the municipal securities held in its portfolio which is generally a function of the underlying credit rating of an issuer, the maturity length of the securities, the securities’ yield, and general economic and interest rate conditions.
Since the Fund invests primarily in obligations of issuers located in Hawaii, the Fund is subject to additional concentration of risk. Due to the level of investment in Hawaii municipal obligations, the marketability and market value of these obligations may be affected by certain Hawaiian constitutional provisions, legislative measures, executive orders, administrative regulations, voter initiatives, and other political and economic developments. If any such problems arise, they could adversely affect the ability of various Hawaiian issuers to meet their financial obligation. Therefore, an investment in the Fund may be riskier than investment in other types of municipal bond funds.
The Fund is an investment company and accordingly follows the investment company accounting and reporting guidance of the Financial Accounting Standards Board (FASB) Accounting Standard Codification Topic 946 “Financial Services – Investment Companies” including FASB Accounting Standard Update ASU 2013-08.
Portfolio securities, that are fixed income securities, are valued by an independent pricing service using methodologies that it believes are appropriate, including actual market transactions, mean between bid and ask prices, broker-dealer supplied valuations, matrix pricing, or other electronic data processing techniques designed to identify market values for such securities, in accordance with procedures established in good faith by the Board of Directors. Securities with remaining maturities of 60 days or less are valued on the amortized cost basis as reflecting fair value. Securities for which market quotations are not readily available or for which available prices are suspect will be valued at “fair value” using methods determined in good faith by or at the direction of the Board of Directors. For these purposes, “fair value” means the price that the Investment Manager reasonably expects the Fund could receive from an arm’s-length buyer upon the current sale of the securities within seven (7) days, after considering all appropriate factors and indications of value available to them. Such value will be cost if the Investment Manager determines such valuation is appropriate after considering a multitude of factors in accordance with established procedures.
The Fund utilizes various methods to measure the fair value of most of its investments on a recurring basis. U.S. generally accepted accounting principles (“GAAP”) establishes a hierarchy that prioritizes inputs to valuation methods. The three levels of inputs are:
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS – (Continued)
March 31, 2017 (Unaudited)
Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities that the Fund has the ability to access.
Level 2 – Observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These inputs may include quoted prices for the identical instrument on an inactive market, prices for similar instruments, interest rates, prepayment speeds, credit risk, yield curves, default rates and similar data.
Level 3 – Unobservable inputs for the asset or liability, to the extent relevant observable inputs are not available, representing the Fund’s own assumptions about the assumptions a market participant would use in valuing the asset or liability, and would be based on the best information available.
The availability of observable inputs can vary from security to security and is affected by a wide variety of factors, including for example, the type of security, whether the security is new and not yet established in the marketplace, the liquidity of markets, and other characteristics particular to the security. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.
The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety, is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Changes in valuation techniques may result in transfers in/out changing an investment’s assigned level within the hierarchy.
The following is a description of the valuation techniques applied to the Fund’s major categories of financial instruments measured at fair value on a recurring basis:
Municipal bonds are categorized in Level 2 of the fair value hierarchy.
The following is a summary of the inputs used in valuing the Fund’s investments, as of March 31, 2017. The inputs or methodology used for valuing securities are not necessarily an indication of the risks associated with investing in those securities.
Valuation Inputs at Reporting Date:
| Description | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Municipal Bonds | | $ | -0- | | | $ | 163,637,623 | | | $ | 246,400 | | | $ | 163,884,023 | |
There were no transfers in to and out of Levels 1 and 2 during the current period presented.
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS – (Continued)
March 31, 2017 (Unaudited)
The following is a reconciliation of Level 3 assets for which significant unobservable inputs were used to determine fair value during the course of the March 31, 2017 period.
Hawaii Health Systems at Value
Balance as of 09/30/2016 | | Realized gain (loss) | | Change in unrealized appreciation (depreciation) | | Purchases (sales) | | Transfers in and/or (out) of Level 3 | | Balance as of 03/31/2017 | |
| $ | 498,960 | | $ | -0- | | ($ | 252,560 | ) | $ | -0- | | $ | -0- | | $ | 246,400 | |
The following table presents additional information about valuation methodologies and inputs used for investments that are measured at fair value and categorized within Level 3 as of March 31, 2017:
| | Fair Value March 31, 2017 | | Valuation Methodologies | | Unobservable Input1 | | Impact to Valuation from an increase in input2 |
| Hawaii Health Systems | | $ | 246,400 | | Discounted cash flow | | Financial Assessment | | Increase |
| 1 | In determining unobservable input, management evaluated the likelihood of obtaining the Hawaii Health Systems defaulted scheduled interest and principal payments. |
| 2 | This column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the unobservable input would have the opposite effect. |
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS – (Continued)
March 31, 2017 (Unaudited)
It is the Fund’s policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute its taxable income, if any, to its shareholders. Therefore, no federal income tax provision is required.
The Fund has reviewed all open tax years for all major jurisdictions, which is the Federal jurisdiction, and concluded that there are no significant uncertain tax positions that would require recognition in the financial statements. As of September 30, 2016, open Federal tax years include the tax years ended September 30, 2013 – September 30, 2016. The Fund has no examination in progress and is also not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly change in the next twelve months.
In order to avoid imposition of the excise tax applicable to regulated investment companies, the Fund intends to declare each year as dividends in each calendar year at least 98% of its net investment income (earned during the calendar year) and 98% of its net realized capital gains (earned during the twelve months ended October 31) plus undistributed amounts, if any, from prior years.
On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 (the “Act”) was enacted. The Act modernizes several of the federal income and excise tax provisions related to regulated investment companies such as the Fund, and, with certain exceptions, is effective for taxable years beginning after December 22, 2010. Among the changes made are changes to the capital loss carryforward rules allowing for capital losses to be carried forward indefinitely. Rules in effect as of the report date limit the carryforward period to eight years. Capital loss carryforwards generated in taxable years beginning after effective date of the Act must be fully used before capital loss forwards generated in taxable years prior to effective date of the Act; therefore, under certain circumstances, capital loss carryforwards available as of the report date, if any, may expire unused. During the fiscal year, the Fund utilized capital gains of $946,306 to offset its prior year capital loss carryforward of $1,156,096. At September 30, 2016, the Hawaii Municipal Fund had a capital loss carryforward of $209,790 which expires in 2017.
The Fund did not incur any net capital losses after October 31, 2015. Net capital losses incurred after October 31, and within the taxable year are deemed to arise on the first business day of the Fund’s next taxable year.
| (C) | SECURITY TRANSACTIONS, INVESTMENT INCOME AND DISTRIBUTIONS TO SHAREHOLDERS |
Security transactions are recorded on the trade date. Interest income is recorded on the accrual basis. Bond discounts and premiums are amortized using the interest method. Distributions to shareholders are declared daily and reinvested or paid in cash monthly.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS – (Continued)
March 31, 2017 (Unaudited)
The net asset value per share for the Fund is determined by calculating the total value of the Fund’s assets, deducting its total liabilities and dividing the result by the number of shares outstanding.
| (2) | INVESTMENT MANAGEMENT FEE AND OTHER TRANSACTIONS WITH AFFILIATES |
Lee Financial Group Hawaii, Inc. (“LFG”)provides the Fund with management and administrative services pursuant to a management agreement and administrative services agreement, respectively. In accordance with the terms of the management agreement and of the administrative services agreement, LFG receives compensation at the annual rate of 0.50% and up to 0.10% of the Fund’s average daily net assets, respectively. For the period ended March 31, 2017, the Fund was allocated, and incurred $33,615 for the Chief Compliance Officer fee which was payable to LFG.
The Fund’s distributor, Lee Financial Securities, Inc.(“LFS”), a wholly-owned subsidiary of LFG, received $122,286 for costs incurred in connection with the sale of the Fund’s shares (See Note 3).
Lee Financial Recordkeeping, Inc. (“LFR”), a wholly-owned subsidiary of LFG, serves as the transfer agent for the Fund. In accordance with the terms of the transfer agent agreement, LFR receives compensation at the annual rate of 0.06% of the Fund’s average daily net assets. LFR has delegated certain of its duties and responsibilities to Ultimus Fund Solutions, LLC as sub-transfer agent. LFR also provides the Fund with certain clerical, bookkeeping and shareholder services pursuant to a service agreement approved by the Fund’s directors. As compensation for these services LFR receives a fee, computed daily and payable monthly, at an annualized rate of 0.10% of the Fund’s average daily net assets.
Certain officers and directors of the Fund are also officers of LFG, LFS and LFR.
The Fund’s Board of Directors, including a majority of the Directors who are not “interested persons” of the Fund, as defined in the Investment Company Act of 1940, adopted a distribution plan pursuant to Rule 12b-1 of the Act. Rule 12b-1 regulates the manner in which a regulated investment company may assume costs of distributing and promoting the sales of its shares.
The Plan provides that the Hawaii Municipal Fund Investor Class may incur certain costs, which may not exceed 0.25% per annum of the Fund’s average daily net assets, for payment to the distributor for items such as advertising expenses, selling expenses, commissions or travel, reasonably intended to result in sales of shares of the Fund.
| (4) | PURCHASES AND SALES OF SECURITIES |
Purchases and sales of securities aggregated $11,860,281 and $12,938,379, respectively, for the Fund during the period October 1, 2016 through March 31, 2017.
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS – (Continued)
March 31, 2017 (Unaudited)
Under an agreement with the Fund’s custodian bank, a portion of the custodian fees were paid by credits for cash balances. Any remaining credits were used to offset expenses of other vendors and service providers. If not for the offset agreement, the assets could have been employed to produce income. Effective August 1, 2014, this arrangement has ceased.
| (6) | TAX COMPONENTS OF CAPITAL AND DISTRIBUTIONS TO SHAREHOLDERS |
The tax character of distributions paid during the years ended September 30, 2016 and 2015 were as follows:
| | | Exempt-Interest Dividends | | | Ordinary Income | | | Long-Term Capital Gains | | | Total Distributions | |
| Hawaii Municipal Fund | | | | | | | | | | | | | | | | |
| 2016 | | $ | 4,264,818 | | | $ | - | | | $ | - | | | $ | 4,264,818 | |
| 2015 | | $ | 4,667,320 | | | $ | - | | | $ | - | | | $ | 4,667,320 | |
The tax character of distributable earnings at September 30, 2016 were as follows:
| | | Undistributed Ordinary Exempt-Interest Income | | | Undistributed Capital Gains | | | Capital Loss Carryforwards | | | Post October Losses | | | Unrealized Gain/(Loss)* | | | Total Distributable Earnings | |
| Hawaii Municipal Fund | | $ | - | | | $ | - | | | $ | (209,790 | ) | | $ | - | | | $ | 8,977,400 | | | $ | 8,767,610 | |
* The difference between book basis and tax basis unrealized appreciation is attributable to market discount on debt securities.
Accounting principles generally accepted in the United States of America require that certain components of net assets be reclassified between financial and tax reporting. These reclassifications have no effect on net assets or net asset value per share. The primary difference relates to the different treatment on amortization of discount for financial reporting purposes versus tax reporting purposes. For the year-ended September 30, 2016, the Hawaii Municipal Fund’s undistributed investment income was decreased by $21,709, and accumulated net realized loss on investments was decreased by $21,709.
HAWAII MUNICIPAL FUND
NOTES TO FINANCIAL STATEMENTS – (Continued)
March 31, 2017 (Unaudited)
| (7) | NEW ACCOUNTING PRONOUNCEMENT |
On October 13, 2016, the Securities and Exchange Commission amended existing rules intended to modernize reporting and disclosure of information. These amendments relate to Regulation S-X which sets forth the form and content of financial statements. Management is evaluating the implications of adopting these amendments and their impact on the financial statements and accompanying notes.
| (8) | SUBSEQUENT EVENTS DISCLOSURE |
In preparing the Fund’s financial statements as of September 30, 2016, the Fund’s management considered the impact of subsequent events for potential recognition or disclosure in these financial statements.
The Hawaii Health Systems bond is in default because the issuer defaulted on its scheduled interest and principal payments. The Fund is pursuing the issuer and paying agent to obtain the payments owed to the Fund. At March 31, 2017 the Hawaii Health Systems bond was valued as a Level 3 security at $246,400 which represented 0.15% of the Fund’s net assets. On May 11, 2017 the Hawaii Health Systems bond was valued as a Level 3 security at $54,020. This security will continue to be fair valued as a Level 3 security until this matter is resolved.
HAWAII MUNICIPAL FUND INVESTOR CLASS (Unaudited)
Shareholder Information
Household Delivery of Shareholder Documents: Only one Prospectus, Annual and Semi-Annual Report will be sent to shareholders with the same last name and address on their Fund account, unless you request multiple copies. If you would like to receive separate copies, please call us at (808) 988-8088. We will begin sending you additional copies within 30 days. If your shares are held through a service provider, please contact them directly.
Business Continuity Plan Summary Disclosure Statement: Lee Financial Mutual Fund, Inc., Lee Financial Group Hawaii, Inc., Lee Financial Securities, Inc. and Lee Financial Recordkeeping, Inc. have developed Business Continuity Plans on how we will respond to events that significantly disrupt our business. Since the timing and impact of disasters and disruptions is unpredictable, we will have to be flexible in responding to actual events as they occur. Contacting Us - If after a significant business disruption you cannot contact us as you usually do at (808) 988-8088, you should go to our website at www.LeeHawaii.com. Please visit our website at www.LeeHawaii.com for the Business Continuity Plan Disclosure Statement.
Proxy Voting Policies and Procedures
The Fund has established Proxy Voting Policies and Procedures (“Policies”) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may request copies of the Policies free of charge by calling (808) 988-8088 or by sending a written request to Lee Financial Group Hawaii, Inc., 3113 Olu Street, Honolulu, HI 96816-1425. Copies of the Fund’s proxy voting records are posted on the Securities and Exchange Commission’s website at www.sec.gov and the Fund’s website at www.LeeHawaii.com and reflect the 12-month period beginning July 1, 2015 and ending June 30, 2016.
Quarterly Statement of Investments
The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission’s website at www.sec.gov or the Fund’s website at www.LeeHawaii.com. The filed form may also be viewed and copied at the Commission’s Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800-SEC-0330.
INVESTMENT MANAGER
Lee Financial Group Hawaii, Inc.
3113 Olu Street
Honolulu, Hawaii 96816-1425
DISTRIBUTOR
Lee Financial Securities, Inc.
3113 Olu Street
Honolulu, Hawaii 96816-1425
FUND ACCOUNTANT
Ultimus Fund Solutions, LLC
225 Pictoria Drive, Suite 450
Cincinnati, Ohio 45246
CUSTODIAN
MUFG Union Bank, N.A.
350 California Street, 6th Floor
San Francisco, California 94104
LEGAL COUNSEL
Drinker Biddle & Reath LLP
One Logan Square
Suite #2000
Philadelphia, Pennsylvania 19103-6996
TRANSFER AGENT
Lee Financial Recordkeeping, Inc.
3113 Olu Street
Honolulu, Hawaii 96816-1425
