Market Sector Update

• Risk assets sold off dramatically starting Feb. 20 due to the COVID-19 pandemic. Investors seeking safety rushed out of corporate bonds and into U.S. Treasuries and cash, which caused equities to decline by nearly 20% in the quarter, while the high-yield sector returned -14.30% and leveraged loans returned -13.00%.
• U.S. Treasuries rallied sharply with the yield on the 10-year U.S. Treasury falling 125 basis points (bps) from 1.92% to 0.67% at quarter-end.
• Energy experienced the largest decline among all sectors, which was true for equity and fixed income. Other sectors performing poorly in the period were gaming and leisure, down 20.4%, as well as transportation, which was down 18.6%.
• Initial jobless claims data for March was a stark indicator of the challenge faced by the domestic economy with 3.28 million claims, a level that was four-times the previous record high.
• As the economic ramifications of COVID-19 and its remediation became apparent, policymakers responded. Unprecedented efforts from the Federal Reserve (Fed), coupled with the $2.2 trillion stimulus package from Washington, helped to stabilize and improve credit markets before the end of the quarter.
• Following the Fed and government actions, non-investment grade credit yields improved by 195 bps during the final six days of the quarter, marking the second swiftest recovery on record, only behind the six-day stretch recovery of 207 bps in January 2009.
• Following a five-week $19.2 billion unprecedented exodus, fund flows improved with high-yield mutual funds tracking their largest weekly inflows on record totaling $7.09 billion.

Portfolio Strategy

• The Fund declined mid-teens during the first quarter, modestly underperforming its benchmark. Underperformance was driven by all three asset class categories – bonds, loans and equities.
• High yield bonds were negatively impacted by credit selection in the telecommunications, gaming and health care sectors. Positive contributions from credit picks within the food and insurance sectors, along with an underweight in the energy sector, were not enough to offset the negatives.
• Leveraged loan investments were negatively impacted by credits in the oil & gas, retail and technology sectors. Leveraged loans did not perform as well as we would have expected in the massive sell-off, driven mainly by technical selling across the board from both outflows in the asset class and collateralized loan obligation selling pressure.
• While equity investments only make up roughly 2% of the portfolio, the decline in the allocation during the quarter detracted from performance.
• Given the level of volatility, the Fund’s allocation across asset classes remained relatively steady. The Fund’s weighting by rating category is 10% BB, 55% B, and 29% CCC.

Outlook

• Prior to March 2020, the words ‘social distancing’ and ‘bending the curve’ were phrases the vast majority of the investing community had probably never heard, let alone given any validity to their occurrence. Today, they will be ingrained into the psyche of the world for generations to come. A true black swan, COVID-19 came out of China with a vengeance that no one (the markets, the health care community, the government) were prepared for. Once the gravity of the virus was fully understood it was all but too late.
• The volatility experienced in the month of March will go down in history as it eclipsed the previous high set back in 2008 when Lehman Brothers failed. Six days later the Fed’s decision to “go all in” on saving the markets from another liquidity crisis has, for the time being, put the bottom in for the markets. The fallout from shutting down the world’s economic way of life is still yet to be determined.
• We are looking for a meaningful increase in high-yield bond and loan defaults in the coming year due to a significantly weaker economy stemming from the COVID-19 outbreak, as well as stress in the energy sector heightened by the production conflict between Saudi Arabia and Russia. As always, our focus when evaluating investments is a company’s business model and competitive advantages in order to weather a recession and perform throughout the cycle.
• That said, we're watching downgrades more so than defaults, especially as BBB rated companies fall to BB ratings. For example, we believe many large and strong companies being downgraded into high yield are creating opportunities for investors like us. New entrants into high yield are expected to surpass $250 billion over the next twelve to eighteen months. Additionally, in hard hit areas like energy we should keep in mind that oil isn't going away. Demand may fall, but there could be opportunities in producers who will make it through the recession.
• Historically, black swan type events have been attractive buying opportunities for those with a long-term investment horizon. When high-yield spreads blow out to levels they are at now, returns 1-year into the future have almost always been positive, and if you go out beyond a year, they've always been positive. This is not to say there aren’t risks ahead. How the economy re-opens and how quickly the world can “get back to work” remains to be seen, but with the blowout in high-yield spreads to over 1,000 bps and today still sitting around 900bps, we think the risk-reward is on investors side in high yield.

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 March 31, 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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