Market Sector Update

• The quarter saw a reversal in risk appetite from the fourth quarter of 2018. The dovish pivot from the U.S. Federal Reserve (Fed) and an anticipated trade deal with China drove strong equity returns, almost erasing last quarter’s decline.
• Typically, a rally in risky asset classes would result in a Treasuries sell-off, but they rallied strongly in the quarter. This was driven by the Fed’s pivot and announcing the end of its balance sheet run-off. The Fed kept the federal funds rate unchanged during the quarter, and the market is now pricing in a greater than 60% chance of a rate cut by the end of 2019.
• The Fed’s adjusted outlook and weak global growth data drove the 2-year yield down 26 basis points (bps) to 2.26% and the 10-year yield down 31 bps to 2.41%. One measure of the yield curve inverted during the quarter. The spread between the 10-year U.S. Treasury Note and the 3-month U.S. Treasury Bill turned negative for the first time since 2007. Historically, an inverted yield curve has implied a forthcoming recession, but the time lag can be significant.
• During the quarter, high yield had a strong return of more than 7% as spreads tightened from 522 bps to 391 bps. Leveraged loans rallied but lagged high yield due to the lack of duration and less spread tightening.
• Overall fundamentals for the investment grade universe continue to weaken, especially as the expansion enters its 11th year. Revenues and earnings before interest, tax, depreciation and amortization (EBITDA) (excluding commodity sectors) were up 4.5% and 4.3% in the fourth quarter of 2018, respectively, a slight decline from the third quarter. Sequentially, leverage for the investment grade universe was up 0.1-times to three-times, while the percentage of the universe that is greater than four-times leveraged was flat at 21%.
• Investment grade issuance was $320 billion in the quarter, down 2% year over year. Net of maturities, net issuance was down a more substantial 28% year over year. Merger and acquisition (M&A) supply was $45 billion, down $18 billion year over year. Financial sector supply was down 16% year over year helping that sector’s relative outperformance in the quarter. Duration continues to be added to the market with average maturity at 12.1 years versus 10.5 years for the same period in 2018.

Portfolio Strategy

• The Portfolio had a positive return, but underperformed its benchmark, the Bloomberg Barclays U.S. Credit Index. The benchmark returned nearly 5%, which was driven by falling rates and the benchmark’s spread tightening from 141 bps to 113bps.
• The Portfolio further reduced its duration relative to the benchmark, but the difference remains modest. This was accomplished by increasing the short and long end of the curve, while reducing 5- to 10-year points on the curve. Benchmark duration rose 0.3 year to 7.2 years at quarter-end. Higher duration means higher price volatility for a given change in spreads.
• The Portfolio made modest changes to overall risk. The Portfolio reduced A and BB exposure and increased AArated credit exposure relative to the benchmark.
• The largest changes in sector positioning were increases in the technology and consumer non-cyclical sectors and decreases in the financial and communications sectors.

Outlook

• We do not anticipate the Fed to hike rates in 2019. We believe macroeconomic data in the second quarter should improve from first-quarter levels, but then soften modestly due to uncertainty regarding trade, Brexit and belowconsensus global growth data.
• We believe credit spreads should widen for the balance of 2019 due to a few factors. First, macroeconomic data points are likely to underwhelm relative to consensus. Secondly, fundamentals in investment grade remain stretched with corporate balance sheets at their most levered levels post-crisis. Lastly, duration in investment grade marketplace continues to rise.
• Given our expectation for modest widening of spreads in 2019, we believe our conservative positioning relative to the benchmark is appropriate. We will be opportunistic in our credit selection and overall positioning to take advantage of the opportunities and dislocations as they present themselves.
• The technical backdrop for spreads remains relatively positive. We believe net supply should be materially lower than last year due to smaller M&A volume and tax changes reducing the incentive to issue debt. However, we expect a higher amount of total fixed income issuance principally from U.S. deficit funding. On the demand side, we see the trends modestly supportive of spreads. Mutual fund flows remain robust and are likely to continue in the near future, but overall yields in the market have compressed, which may reduce demand.

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, 2019, 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. Past performance is not a guarantee of future results.

The Bloomberg Barclays U.S. Credit Index measures the investment grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related bond markets, including a non-corporate component of non- U.S. agencies, sovereigns, supranationals and local authorities. It is not possible to invest directly in an index.

Risk factors: The value of the Fund's shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. These and other risks are more fully described in the Fund's prospectus. Not all funds or fund classes may be offered at all broker/ dealers.