Market Sector Update

• The second quarter marked a strong rebound in high yield as the ICE BofA US High Yield Index, the Fund’s benchmark, returned 9.6%. However, year to date (YTD) the index is still down 4.77%.
• Leveraged loans saw a strong rebound returning 9.78% in the quarter. Similar to the high yield index, the leveraged loan asset class is down 4.5% YTD.
• Energy was the worst performing sector in the first quarter, but recovered to become the best performing sector in the second quarter returning 33.08%. The automotive sector had the next best performance with a return of 12.34%. The worst performing sectors were transportation (-0.31%) and broadcasting, which returned 2.97%.
• The default cycle that began in the first quarter accelerated dramatically in the second quarter. The total amount of defaults or distressed transactions was $82.2 billion in the quarter, compared with $24 billion in the prior quarter. The YTD total of $106.1 billion, inclusive of distressed exchanges, ranks as the second highest annual default total on record.
• New issuance activity in high yield exploded in the quarter setting records with $145.5 billion in gross issuance and $75.5 billion in net issuance. This easily exceeded the gross issuance record of $121.2 billion in the second quarter of 2014 and net issuance record of $52.6 billion in the first quarter of 2015. Leveraged loan issuance only totaled $46.6 billion, the lowest level in 17 quarters. Forty-two loans priced in the month of June for $28.8 billion, followed by 22 loans that priced in the month of May for $9.9 billion.
• The quarter saw an unprecedented amount of inflows into the high yield asset class. April, May and June had inflows of $17.1 billion, $20.5 billion and $9.7 billion, respectively, bringing the total for the quarter to $47.2 billion. Leveraged loan funds continued to see outflows in the quarter, totaling $4.9 billion. This marks an improvement versus first quarter’s outflows of $16.3 billion.

Portfolio Strategy

• The Fund had a high-single-digit positive return in the quarter, but trailed its benchmark and was in line with its peer group.
• The high-yield bond portion of the Fund outperformed the benchmark index and peer group. Contributors to performance were credit picks in health care, underweights in the telecommunications sector and media sector. Detractors included zero exposure to the energy midstream sector, which returned 30% in the quarter, followed by credit picks in the aerospace/defense sector.
• Leverage loan investments had a positive return, but underperformed the benchmark and peer group. Two credits were responsible for the vast majority of the underperformance in the loan portfolio.
• The Fund’s mix of bonds and loans changed slightly during the quarter with the bond portfolio increasing slightly and leveraged loan exposure decreasing.

Outlook

• The declines in high-yield credit spreads in April and May paused and stayed relatively flat in June. Both equity and fixed income debt markets have rallied in front of the “bending of the curve” of COVID-19 cases. The Federal Reserve (Fed) has also continued to express its willingness to do “whatever it takes” to provide liquidity and support capital markets.
• The amount of stimulus across the world from central banks is unprecedented. The balance sheets of the Fed, European Central Bank, Bank of England, Bank of China and the Reserve Bank of Australia are up over 100% on average. The Fed’s balance sheet has gone from roughly $4 trillion at the end of March to more than $7 trillion today.
• Another fiscal stimulus package appears to be on the horizon. Republicans seem to be in favor of capping any potential package, while Democrats have already passed a bill in the House for approximately $3 trillion. If another stimulus bill is passed, it would be the fifth COVID-19 bill and would likely provide additional support for the recovery well into the third quarter.
• We remain constructive on the high-yield market at current credit spread levels of 675-700 basis points. Our view is based on the backdrop of Fed support and scientists working towards a vaccine that we believe would ultimately get the world back to work and progressing towards social normalization. Risks on the horizon that we are watching include: the U.S. presidential election, second wave of COVID-19 infections, spillover in job losses beyond small businesses and acceleration of both downgrades and defaults.

The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 30, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

Risk factors: The price of the Fund’s shares will fluctuate with market conditions and other factors. Fund shares are not guaranteed or endorsed by any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation. Closed-end funds frequently trade at a discount from their net asset values (NAVs), which may increase an investor’s risk of loss. At the time of sale, shares may have a market price that is below NAV, and may be worth less than the original investment. There is no assurance that the Fund will meet its investment objective. Investing in high-income securities may carry a greater risk of nonpayment of interest or principal than with higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized, may be subject to restrictions on resale and sometimes trade infrequently on the secondary market.

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

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Ivy Investment Management Company (IICO) serves as the Fund’s investment adviser. IICO is a wholly-owned subsidiary of Waddell & Reed Financial, Inc.

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