California Tax-Exempt Fund

California Tax-Exempt

as of June 30, 2010

Treasury yields plummeted during the second quarter, with 10-year yields declining 90 basis points (0.90%), as investors sought the safe haven of U.S. government bonds. Markets were rattled by fears of sovereign debt restructuring by weaker European countries, particularly Greece. Bailouts by foreign central banks failed to instill confidence, and riskier assets, such as equities, were sold. In addition, doubts about the strength and sustainability of the U.S. economic recovery rose, as job growth stalled and the housing market softened. Municipal bonds rallied, but significantly lagged gains by their taxable counterparts, as yields on 10-year high-grade municipals fell by roughly 30 basis points (0.30%).

The California Tax-Exempt Fund gained 2.26% during the quarter, for a year-to-date total return of 3.64%. Shareholders benefited from the Fund's relatively long duration during a period of falling interest rates and rising bond prices. In addition, we rebalanced maturities by reducing exposure to lower-yielding money market positions and adding to longer-intermediate bonds, which captured most of the steepness of the California yield curve. The Fund continues to own higher-quality securities on a relative basis, with just over 2% exposure to the BBB-rated category. In terms of sector allocation, we increased our holdings of highly liquid, revenue-backed securities that have grown in popularity.

Going forward, we will track in-state demand for tax-exempts as Californians anticipate higher federal tax rates. In addition, we will closely focus on actions by the legislature and the governor to resolve budget imbalances. Moreover, we will be wary for any signs of inflationary pressures.

If you are an investor who wants high current income that is exempt from regular federal income tax and California state personal income tax, you may find this Fund attractive. It is well suited for income-oriented investors in higher tax brackets who are willing to accept some risk of principal in exchange for higher yield potential. Income from the Fund may be subject to federal alternative minimum tax (AMT), state and local taxes.

Concentrate our investments in California state-specific, investment-grade municipal instruments which are exempt from federal income tax and California state personal income tax while maintaining an average maturity, under normal circumstances, between 10 and 30 years.
Invest in high-quality securities, primarily investment-grade debt.
Select investments on the basis of their relative value with a focus on total return.

Not FDIC insured | May lose value | No bank guarantee

†Northern tax-exempt fixed income funds' Average Duration is calculated using the modified duration formula. Other Northern fixed income funds show the option-adjusted duration. Duration is a measure of a bond fund's sensitivity to changes in interest rates.

*Distribution rate and tax-equivalent distribution rate represent the annualization of the Fund's distributions for the prior month ending on the date shown, including capital gain distributions. The 30-day SEC yield and tax-equivalent 30-day SEC yield represent the annualization of the Fund's net investment income, excluding capital gain income. The tax-equivalent distribution rate and tax-equivalent 30-day SEC yield are based on an assumed tax rate of 38.0% for Arizona, 41.0% for California and 35.0% for national municipal funds.

**Per share paid out July 26 with a record date of July 23. The amount shown represents dividends paid for net investment income and excludes distributions from capital gain income.

Please carefully read the prospectus and summary prospectus and consider the investment objectives, risks, charges and expenses of Northern Funds before investing. Call 800-595-9111 to obtain a prospectus and summary prospectus, which contains this and other information about the funds.