Market Sector Update

• The ICE BAML US High Yield Index continued its streak of positive returns in the first quarter of 2021, returning 0.90%, which is the fourth quarter in a row of positive consecutive returns. Spreads on the index ended the quarter at 352 basis points (bps), which is 35 bps tighter versus year end.
• Leverage loans continued to gain in the quarter, returning 1.86% as the markets believe rates have bottomed and the economic recovery takes shape. Spreads ended the quarter at 420 bps versus 460 bps at year end. Split B/CCC loans (+6.66%) outperformed B loans (+1.60%) and BB loans (+0.83%).
• The best performing sectors in the ICE BAML US High Yield Index were entertainment, airlines and publishing, which were up 21.6%, 5.1% and 4.3%, respectively. Conversely, the worst performing sectors were utilities, restaurants and cable, which returned -1.3%, -0.99% and -0.57%, respectively.
• The $3.4 billion of default/distressed volume is the lowest quarterly default total since $2.3 billion defaulted in third quarter of 2018. Including distressed exchanges, the U.S. high-yield default rate decreased to 5.37% at the end of the quarter. Meanwhile, the loan default rate including distressed exchanges decreased to 3.66%.
• For the quarter, the $158.6 billion of high yield new issuance easily surpassed the prior high of $145.5 billion in second quarter 2020. Leverage loan new issuance totaled $300.5 billion in the period, and leverage finance markets remain wide open.
• High yield funds reported outflows of $10.2 billion in the quarter versus positive flows of $6 billion last quarter. Floating rate loan funds reported inflows of $11.1 billion in the period as investors respond to stronger global growth rates and a corresponding rise in interest rates.

Portfolio Strategy

• The Fund meaningfully outperformed during the quarter returning mid-single digits versus 0.90% for the ICE BAML US High Yield Index and 0.93% for the Morningstar peer group.
• The high yield bond portion of the Fund outperformed the index by more than 200bps. Contributors to performance were credit picks in telecommunications (both wireline and wireless), rentals and aerospace/defense. The biggest detractor from performance was driven by an underweight to the energy sector.
• Leverage loan investments outperformed both the index and the peer group by more than 400 bps. Credits in the retail, manufacturing and electronic sectors drove the outperformance. Detractors from performance were credits in the food and broadcasting sectors.

Outlook

• In our last outlook, we stated that credit markets were wide open to those wishing to issue debt and at absolute yields that were the lowest in history. We also observed that the vaccine rollout was just beginning but looked to have a high probability of being ramped up and successful by the end of May or June. Both characterizations remain true today and continue to drive the credit and equity markets tighter (in terms of spreads) and higher (in terms of overall prices), respectively.
• As investors have started to see the light at the end of the COVID-19 tunnel and economic activity has started to accelerate, rates have moved up quickly with the 10-year U.S. Treasury rate increasing 76 bps so far this year. With vaccinations ramping to over three million per day on average, herd immunity should be upon us mid-to-late summer. If we remain on this track and variants of the virus remain under control, we think the Federal Reserve (Fed)’s stance on accommodative policy for the foreseeable future will become increasingly debated. This will most likely lead to a continued march higher in rates. Longer term, we believe the Fed is more worried about deflation than inflation and will want to see solid data on inflation before tapering purchases and ultimately raising the federal funds rate some time in 2022.
• High yield credit has shrugged off the increase in rates with positive returns year to date. It is our view that rising rates aren’t necessarily a bad thing for high yield credit. Higher rates normally are accompanied by improving economic growth, better corporate profits and lower unemployment, all of which leads to levered companies being able to better service their debt obligations as the economy recovers.
• We continue to have an outsized weighting to leverage loans which should serve us well as they have low interest rate risk and their seniority in the capital structure makes them less susceptible to price declines. Loans have also benefitted from a technical tail wind this year as the asset class has seen inflows of $11 billion.
• We acknowledge that with spreads and yields being at or near historical lows, finding great risk reward investments is increasingly difficult. We have passed on opportunities where the compensation, i.e. coupon, has not fit the risk. We will continue to let our fundamental research drive our investment decisions with a laser focus on making sure we are being compensated for the risks we are taking.

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, 2021, 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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