Performance summary

For the year ended February 28, 2021, Class A shares of Invesco AMT-Free Municipal Income Fund (the Fund), at net asset value (NAV), underperformed the Bloomberg Barclays Municipal Bond Index.

Your Fund’s long-term performance appears later in this report.

Market conditions and your Fund

The broad municipal bond market experienced positive returns for the seventh consecutive year in 2020, even despite the unexpected twist of the coronavirus (COVID-19) global pandemic that pierced the markets and forced society to navigate uncharted waters in March 2020. 

Investment-grade municipal bonds returned 1.06%, high-yield municipal bonds returned 1.27%, and taxable municipal bonds returned 0.43% during the year.¹  

The year began with an unexpected major market shift as the global spread of COVID-19 ignited macroeconomic concerns. Significant equity market sell-offs incited a flight to quality that caused a strong municipal rally in February 2020. In March, however, a flight to cash caused extreme volatility and price declines across the municipal market. 

Municipal funds averaged about $10 billion per week in outflows during March.² Total fund outflows were $21 billion for the first quarter of 2020, with the majority in the high-yield segment.² In general, many high-yield municipal funds hold anywhere from 30% to 60% of their portfolios in investment-grade securities. As a result, funds had been selling both high-yield and investment-grade securities into a distressed market to meet shareholder redemptions. This led to price declines across the municipal universe. 

Continued uncertainty regarding COVID-19 and its economic effects caused other major dislocations in the marketplace, including US Treasuries. Near the end of March, 10-year AAA-rated^† municipals traded at yields that were roughly 370% of the yield on comparable maturity US Treasuries – well above the historical norm of approximately 90%.³  

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted at the end of March, gave the US Federal Reserve (the Fed) the ability to invest in programs or facilities established by the Fed which included the Municipal Liquidity Facility (MLF). The CARES

Act also provided $150 billion for state and local governments and established the Disaster Relief Fund. 

The Fed cut the federal funds rate twice in 2020 during unscheduled emergency meetings in March in response to COVID-19, consisting of half of a percentage and a whole percentage point leaving the target range 0.00% to 0.25%.⁴  

Investors continued to sell municipal bonds in April amid disruption from the COVID-19 pandemic. However, May and June saw municipal market performance improve despite ongoing market turmoil. As April began, many states maintained quarantines with indeterminate timelines for closures of non-essential businesses. 

Throughout the summer months, the municipal market began to rebound with gains that erased the earlier 2020 losses. The municipal market continued to benefit from federal support from the MLF, which enabled two issuers per state, city, or county to use proceeds from the sale of notes to service their debt payments. While only two issuers accessed the MLF, the State of Illinois and the Metropolitan Transportation Authority, the availability of the program provided a psychological safety net for the market. 

As the COVID-19 pandemic continued into fall and winter; most states saw cases rise amid colder weather and holiday gatherings, which led to renewed restrictions on non-essential businesses and had a negative effect on the economy. Attention moved to the US Presidential election and medical advancements toward a vaccine. 

We believe the election of Joe Biden and Kamala Harris, aligned with a Democrat-controlled Congress, could benefit municipal bonds given their stated support for numerous initiatives, including a larger stimulus bill and an infrastructure package, as well as health care and tax reform. 

A highly demanded second stimulus package was signed at the end of 2020. The $900 billion Omnibus Spending and COVID

Relief Deal included funding for small businesses, the unemployed, and health care workers. 

In December, several pharmaceutical companies reported long-awaited breakthroughs and a vaccine with 95% effectiveness was approved for widespread distribution, significantly improving both investor and public sentiment. 

New municipal issuance totaled $465 billion for the year, up 3% from the previous year’s $449 billion.⁵ Taxable municipals played a significant role in this increase in 2020, having 43% of new issuance.⁵ This uptick can be attributed to recent changes in tax laws. Municipalities are no longer able to refinance existing debt with new tax-exempt debt, thus causing an uptrend in taxable municipal issuance. 

Municipal credits have a long history of low default rates as many provide essential services to all Americans. Most municipal issuers were in strong financial shape heading into the COVID-19 pandemic. Despite speculation, a flurry of downgrades has not yet occurred, we think mainly because most issuers have a rainy-day fund or cash on hand for difficult times. Though there could be small, isolated pockets of defaults in the future, we believe the vast majority of municipal bonds will stay current on principal and interest, as history has shown. 

At the close of the year, the House passed the $1.9 trillion American Rescue Plan Act of 2021. Subsequent to year end, on March 11, 2021, this bill was signed into law. The US Food and Drug Administration issued an emergency use authorization for a third vaccine. February 2021 also brought $34 billion in municipal bond supply, higher than the average supply for the last five years for the month. 

During the year, security selection in state general obligation bonds and the special tax sector contributed to the Fund’s performance relative to its style-specific benchmark. Security selection in non-rated bonds significantly contributed to the Fund’s relative return. On a state level, security selection in Alabama domiciled bonds also added to the Fund’s relative performance. 

Conversely, security selection in BBB-rated^† bonds detracted from the Fund’s performance relative to its style-specific benchmark over the year. Security selection in local general obligation bonds also detracted from the Fund’s relative performance. On a state level, security selection in Puerto Rico and Virginia holdings was a detractor from the Fund’s relative results. 

During the year, leverage contributed to the Fund’s performance relative to its style-specific benchmark. The Fund achieved a leveraged position through the use of inverse floating rate securities or tender option bonds. The Fund uses leverage because we believe that, over time, leveraging provides opportunities for additional income and total