Portfolio Manager Commentary Overview, strategy, and outlook: As of April 30, Money market overview by Dave Sylvester

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1 Wells Fargo Advantage Money Market Funds Portfolio Manager Commentary Overview, strategy, and outlook: As of April 30, 2012 Money market overview by Dave Sylvester In our conversations with our shareholders and distribution channel partners, we get a number of questions about the markets and our money fund portfolios. For the last several months, the most frequently asked questions (FAQ) have centered on our view of Europe, our opinion on potential regulatory changes, and our holdings of municipal variable-rate demand notes (VRDNs) and tender option bonds (TOBs) in our prime funds. These are all good questions; the first two are very topical, and with (depending on which fund you look at) a quarter to a third of our prime funds assets invested in the municipal sector, our stake is larger than your average prime money fund. As for our outlook for Europe, or more specifically for eurozone-based financial institutions, we remain cautious and have not re-entered that market at this point. Though we see the potential for safety and value in some sectors in Europe, and we would agree that the liquidity injected by the European Central Bank (ECB) was important in buying time for the eurozone nations and their banks, it remains to be seen what will be done with that time. The puzzle of how to balance varying levels of competitiveness and fiscal discipline among nations sharing a single currency has not been solved, and slowing economic growth in the eurozone is exacerbating the issue at both the fiscal and political levels. While there are some signs that conditions are stabilizing, the yields available from some of these issuers remain elevated. We do not think that is without reason and so remain on the sidelines for the moment. Many regulatory officials continue to clamor for change, with one important official citing the return of some prime funds to the eurozone markets as evidence of the need for additional regulation, while others offer different reasons. Exactly what, when, or even why changes may take place is still not completely clear to us. What is clear is that many money fund shareholders find the changes that are currently being publicized to be unacceptable. Recent surveys 1 of institutional shareholders reveal that many plan to decrease their use of money market funds should further regulatory change be adopted. Should events flare up again in the eurozone, it is not unreasonable to expect that credit spreads might widen further. In this event, securities with a longer final maturity would be susceptible to a greater price decline than would shorter-term securities. For this reason, we believe that the less volatile, shorter-term weighted average life (WAL) 2 structure is a better choice for positioning prime money market fund portfolios, though it does entail a sacrifice in yield. And should regulatory change prompt our shareholders to look for alternative solutions to meet their needs, we believe this will ensure that our funds are well positioned to satisfy their need for daily liquidity. A clouded credit outlook in Europe and an uncertain regulatory environment lead us to conclude that the most appropriate structure for a prime portfolio is one that is both short and highly liquid. In this market environment where we want to construct portfolios that have minimal exposure to eurozone financials, are highly liquid, have a relatively short WAL, and contain solid credits VRDNs and TOBs meet all four of these criteria. VRDNs are long-term municipal securities that feature both a periodic coupon reset and a tender option that allows an investor to periodically sell the securities for payment at par plus accrued interest. Generally, the interest rate on VRDNs is reset every one to seven days based on the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index. 3 VRDNs also generally have a one-day or sevenday put or demand feature that enables the investor to sell the securities back to a financial intermediary such as a remarketing agent, tender agent, or trustee on a one-day or seven-day notice. The daily or weekly coupon reset and one-day or seven-day par put or demand feature are the two key structural characteristics that make VRDNs attractive, liquid, stable value investments for money market funds, by combining the ability to invest in a wide range of high-quality municipal securities with the benefit of SEC 2a-7-eligible short-term securities. While issuers of VRDNs may provide their own liquidity to fund the purchase of bonds that are tendered, most VRDNs benefit from third-party credit and/or liquidity enhancement, such as letters of credit and standby bond purchase agreements. Such credit and liquidity enhancements are typically provided by a highly rated bank or other financial institution and are designed to ameliorate the risk of nonpayment by an issuer. 1

2 TOBs are similar to VRDNs in that they also provide the benefits of a periodic coupon reset with the put option feature to sell the securities for payment on demand at par. An important difference between VRDNs and TOBs is that the former are primary market instruments, while the latter are created in the secondary market. They share more similarities than differences, though, since remarketing agents are responsible for resetting the rates on the TOBs; a remarketing agent is responsible for finding new buyers for tendered securities; and the liquidity facilities provided by highly rated banks and other financial institutions acts as a backstop for tendered securities to ensure that investors are paid par plus accrued interest on demand. VRDNs and TOBs have historically been a core holding for most municipal money market funds due to their ability to provide liquidity and principal preservation in cash portfolios. The safety and soundness of the structures of these securities have endured through various market conditions and economic cycles and most notably persevered during the 2008 financial crisis. As a result, the popularity of these securities has increased over the years due to growing demand from nontraditional investors seeking the safety and liquidity offered by these products. It was once the case that because the income from many VRDNs and TOBs was exempt from federal (and in some cases state) income taxes, their yields were significantly below equivalent taxable investments. More recently, however, the compression in yields and declining demand from municipal money market funds and corporate investors have led remarketing agents to reset VRDN and TOB rates at a level that is more in line with taxable yields. SIFMA seven-day VRDN index vs. federal funds effective rate (%) Federal funds rate SIFMA Source: Bloomberg, LP Number four on our FAQ list is, Why is your fund s yield lower than this other fund s? It is understandable though on another level, disappointing that some investors remain focused on yield. It is, after all, one way to measure the price one pays for a product where, for a long time, expenses were the single most important determinant of the net yield of a money market fund. Now, with fee waivers in place for many funds and wider spreads between different types of money market investments, credit quality and duration have become important yield determinants as well. In the graph below, we display the gross yield (before expenses are deducted) of the 25 largest prime money market funds compared with their WALs. We also show the yield curves for London Interbank Offered Rate (LIBOR) and for asset-backed commercial paper (ABCP) sponsored by U.S., Canadian, or Japanese financial institutions. Gross yield vs. weighted average life (25 largest prime money market funds as of ) Gross yield (%) Gross yields LIBOR ABCP: U.S., Canada, Japan Cash Heritage Weighted average life (days) Source: Crane Data From this chart, we can see that the LIBOR yield curve is steeper than that of the U.S.-, Canadian-, and Japanesebacked ABCP; this is likely reflecting the uncertainty in the European financial markets. We can also see that the gross yield of most of these funds falls somewhere between these two yield curves and that, in many cases, the longer a fund s WAL, the higher its gross yield. So the answer to question #4 ties back to the first two questions; because of the uncertain credit and regulatory environment, we maintain a relatively short and liquid portfolio that, in a steep yield curve environment, has resulted in a somewhat lower yield. Clearly, others disagree, but in our view, the additional yield afforded by the steepness of the LIBOR curve has been insufficient compensation for the risks involved in extending maturity. 2

3 Rates for sample investment instruments Current month-end % (April 2012) Sector 1 day 1 week 1 month 3 month 6 month 12 month U.S. Treasury repo U.S. Treasury bills Agency discount notes LIBOR Asset-backed commercial paper First Tier Dealer commercial paper First Tier Municipals First Tier Sources: Bloomberg, LP, and WellsCap Strategies for the prime funds by Laurie White In mid-march, Moody s Investors Service announced an expected timetable for the conclusion of its reviews of more than 100 Western European banks and of eight non-european global capital markets intermediaries (GCMIs). At that time, Moody s contemplated completing its reviews by the end of May and noted in particular that it would release results on the GCMIs during the week of May 14. However, on April 13, Moody s revised its timetable in a follow-up statement: Moody s is taking an appropriately deliberate approach during this review process and will conclude when it is confident that all relevant information has been received and analyzed. As noted in a previous communication on March 15, the review timeline is subject to change and Moody s intends to keep the market informed of any relevant updates. The expectation is that the review will conclude by the end of June. The relief provided by the ECB s Long-Term Refinancing Operations (discussed in January and March commentaries) and Greek bondholders agreement to debt restructuring largely calmed the waters swirling about the eurozone situation. This has allowed market participants to focus on recent economic indicators, which have started to show that eurozone gross domestic product growth is slowing and that some economies, such as the U.K. and Spain, may be double-dipping into recessionary territory. This, in turn, has spurred a burgeoning movement in sentiment, both popular and political, away from the imposition of further austerity measures (or even the relaxation of current targets) and toward measures designed to accelerate growth in the region. Worth noting is that both France and the Netherlands are closely aligned with Germany on austerity and both governments have the potential to change political affiliations in the near future; this may have longer-term implications for resolution of the eurozone crisis. Despite this uncertainty, investors remained relatively unfazed by developments that only months before may have caused dislocation. Investors continued to buy European financial credits, just as they have done in the previous months, and have shown some indications of lending money in longer tenors than they have in the past. This has helped increase liquidity to these markets. Evidence that market conditions show some signs of stabilizing can be found in the TED spread the yield difference between three-month U.S. Treasury bills and Eurodollar deposits. In the graph on the following page, we can see that it widened last fall in the face of uncertainty around the implications of some European sovereign credit deterioration, then narrowed early this year as the ECB sought to inject liquidity into the markets. For the past couple of months, the spread has been fairly stable, and while this might not be a sign of fundamental improvement, it does at least indicate that the market does not perceive conditions to be worsening. Indeed, perception is being borne out during earnings season; overall, European banks are reporting positive earnings surprises versus analysts expectations, and even the small handful that have disappointed have shown improved operating results versus the fourth quarter and the previous year. Their balance sheets are in good condition, capital ratios are fairly high, and funding needs have been fairly minimized. So overall, the financial picture seems to be gradually stabilizing, or even improving. 3

4 U.S. Treasury-Eurodollar spread (%) TED spread Source: Bloomberg, LP While we see some good news in some sectors of the European Union economy, we will continue to maintain a high degree of liquidity and trade up the quality spectrum in security selection as we monitor the continent for further signs of stabilization. This will allow us to adjust quickly to changing market conditions or strategic changes, as well as preserve our commitment to stability of principal and liquidity. Strategies for the U.S. government funds by Mike Bird and John Kelly The main event for the month was the long-awaited contraction in Treasury bill (T-bill) supply, which occurred on schedule on April 19, with the maturity of $40 billion in cash management bills (CMBs) issued by the U.S. Department of the Treasury (the Treasury) to cover the Treasury s seasonal income tax needs. In the aftermath of this removal of a sizeable amount of T-bill collateral from the repo market, Treasury repo rates declined from an average of 0.21% to date in April to 0.12% on April 19; yields on T-bills maturing in six months or less also began to fall, beginning what many thought would be a quarter-long journey from the near-zero level of 10 basis points for three-month T-bills to even nearerzero levels. The rolling off of the CMBs was expected to be just the beginning of supply reductions, but over the next few days, the Treasury surprisingly did not shrink its upcoming fourweek, three-month, and six-month auctions, leaving the market facing a different supply equation. The reduction in repo rates lasted all of three days, and then rates bounced back into the upper teens. Repo rates are still likely to decline as the quarter rolls on, but the decline will likely be gradual and choppy, as events that temporarily add collateral to the system, such as regular mortgage and Treasury settlements, and Federal Reserve Twist sales, will elevate rates for a few days each time Looking ahead, the Treasury may soon announce its intent to issue floating-rate notes. Among the parameters of the program still to be addressed are the term (market chatter is one to two years); the underlying index (federal funds effective, at least initially, with other options being T-bill auction results, repo, or LIBOR); size; and first issuance date (late 2012 or early 2013). Any floating-rate notes would be issued as alternatives to current instruments, and which current securities are reduced to make way for the floaters is another key question. A reduction in overall T-bill supply would be problematic for some market participants who may be limited by their mandate to T-bills or fixed-rate instruments. Another dynamic could be the entry of new buyers who prefer floating-rate notes. It s conceivable that floating-rate Treasury notes would be appropriate investments in each of our government funds, and we ll consider them, if and when they arrive, with an eye to their impact on the funds weighted average lives. In light of these market conditions, we continue our investing approach of laddering maturities in each of the government funds to provide liquidity, and looking for strategic opportunities in the Wells Fargo Advantage Government Money Market Fund to add government-sponsored enterprise discount notes and fixed- and floating-rate securities, as well as FDIC-guaranteed securities while they remain available. Strategies for the municipal funds by Jim Randazzo The municipal money markets experienced the typical outflows associated with seasonal tax payments during the month of April, which, together with other unfavorable supply/demand characteristics, led to persistent upward pressure on yields in the short end of the curve. In particular, rates in the overnight and weekly segments have remained somewhat elevated in sympathy with the unexpectedly higher levels being offered on comparable investments in the taxable markets. In addition, the municipal market as a whole experienced a flurry of new-issue activity during the month, with volume in the money market space increasing roughly 60% on a year-over-year basis. As a result of these various factors, rates in the municipal money market slowly rose to levels last seen during tax time in However, these taxtime-related conditions are typically temporary in nature and tend to normalize as the year progresses. Rates on overnight VRDNs and TOBs averaged roughly 0.22% for the month, up from roughly 0.14% for the month of March. In the weekly market, the SIFMA seven-day floater index 4 steadily rose to 0.26% on April 18, before easing to 0.25% on the April 25 reset. Further out the municipal money market curve, yields increased a few basis points across the board with 4

5 high-grade commercial paper scales backing up to the 0.18% to 0.20% range for maturities of anywhere from 30 days to 90 days. On the long end, yields were generally stable, with the one-year high-grade scale increasing from 0.18% to 0.20%. Nevertheless, demand for high-quality names in the money market space remains strong during a period of lackluster supply. For example, the City of Milwaukee successfully issued $100 million of promissory notes with a December 2012 maturity at a low yield of 0.12% While we have enjoyed the seasonal increase in floating rates in the municipal money market space during the month, our primary objective behind investing in daily and weekly variable-rate demand notes and tender option bonds continues to be liquidity and principal preservation. Accordingly, we have continued to focus our investments in this segment of the market while remaining particularly selective in our longer-dated fixed-rate purchases. As a result of this strategy, we have maintained shorter than average weighted average maturities in our portfolios in order to emphasize liquidity for defensive purposes. On the horizon While there are some signs that markets may be stabilizing in Europe, pending regulatory and rating agency actions are keeping the level of uncertainty high. At the same time, the supply of eligible money market instruments remains constrained. This environment leads us to focus on stability and liquidity as we wait for the picture to clear. Nonetheless, we remain mindful of the risks and rewards across the entire market spectrum and carefully balance the two as we invest for our money fund portfolios. For more information, please contact: Institutional Sales Desk: Website: wellsfargoadvantagefunds.com (Click Institutional Cash Management ) View current money market fund performance. View a list of complete holdings. 1. Money Market Fund Regulations: The Voice of the Treasurer, Treasury Strategies, Inc., April The WAL is the weighted average final maturity of a fund s assets. Weighted average final maturity (WAFM) is an average of the final maturities of all securities held in the portfolio, weighted by their percentage of total investments. The maturity of a portfolio security is the period remaining until the date on which the principal amount is unconditionally required to be paid or, in the case of a security called for redemption, the date on which the redemption payment is unconditionally required to be made. The calculation of WAFM allows for the maturities of certain securities with demand features to be shortened, but unlike the calculation of WAM, does not allow shortening of the maturities of certain securities with periodic interest rate resets. WAFM is a way to measure a fund s potential sensitivity to credit spread changes. 3. The SIFMA municipal swap index, produced by Municipal Market Data (MMD), is a seven-day high-grade market index composed of tax-exempt variable-rate demand obligations from MMD s extensive database. You cannot invest directly in an index. 4. The SIFMA seven-day floater index, produced by Municipal Market Data (MMD), is a seven-day high-grade market index composed of tax-exempt variable-rate demand obligations from MMD s extensive database. You cannot invest directly in an index. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Wells Fargo Advantage Money Market Funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund. A portion of the Municipal Money Market Fund s income may be subject to federal, state, and/or local income taxes or the alternative minimum tax (AMT). Any capital gains distributions may be taxable. For the Government Money Market Funds, the U.S. government guarantee applies to certain underlying securities and not to shares of the fund. The views expressed and any forward-looking statements are as of and are those of David D. Sylvester and the money market team at Wells Capital Management, subadvisor to the Wells Fargo Advantage Money Market Funds, and Wells Fargo Funds Management, LLC. Discussions of individual securities, or the markets generally, or any Wells Fargo Advantage Fund are not intended as individual recommendations. Future events or results may vary significantly from those expressed in any forward-looking statements; the views expressed are subject to change at any time in response to changing circumstances in the market. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements. Carefully consider a fund s investment objectives, risks, charges, and expenses before investing. For a current prospectus and, if available, a summary prospectus, containing this and other information, visit wellsfargoadvantagefunds.com. Wells Fargo Funds Management, LLC, a wholly owned subsidiary of Wells Fargo & Company, provides investment advisory and administrative services for Wells Fargo Advantage Funds. Other affiliates of Wells Fargo & Company provide subadvisory and other services for the funds. The funds are distributed by Wells Fargo Funds Distributor, LLC, Member FINRA/SIPC, an affiliate of Wells Fargo & Company Wells Fargo Funds Management, LLC. All rights reserved. 5

Overview, Strategy, and Outlook, as of April 30, 2010

Wells Fargo Advantage Money Market Funds Portfolio Manager Commentary Overview, Strategy, and Outlook, as of April 30, 2010 Rates in the money markets have begun to move higher, despite the absence of