Market Sector Update

• The second quarter saw a strong recovery in risk assets due to the scale and speed of the fiscal and monetary responses to the COVID-19 pandemic, which caused domestic equities to rally more than 20%.
• The Federal Reserve (Fed) took incremental actions related to its plans to buy corporate bonds in the quarter, most notably the April 9 decision to add certain parts of the high yield market to its purchase program. The program was not active for much of the quarter, but beginning on May 12the facilities created by the Fed began purchasing investment grade and high yield ETFs. Subsequently, on June 12 the facilities began purchasing individual corporate bonds.
• Despite the upswing in risk assets, U.S. Treasury yields did not rise as one would expect. The Fed consistently communicated it would not raise rates for “some time,” and concerns lingered over the shape of the recovery as well as the potential for a second wave of the virus. The yield on the 10-year U.S. Treasury fell 1 basis point (bp) to 0.66%, while the yield on the 2-year U.S. Treasury fell 10 bps to 0.15%. During the quarter, the yield curve steepened slightly as the difference between the 10-year U.S. Treasury and the 2-year U.S. Treasury rose 8 bps to 50 bps.
• The spread on the Fund’s benchmark, the Bloomberg Barclays U.S. Credit Index, fell dramatically from 255 bps to 142 bps. High yield gained more 10% as the spread on the Bloomberg Barclays US Corporate High Yield fell from 880 bps to 626 bps, while leveraged loans gained 9.7%.
• Issuance picked up substantially in the quarter as companies sought liquidity in an uncertain economic environment, while the Fed’s support reopened capital markets. Second quarter issuance surged to $834 billion, up 187% over last year. Year-to-date issuance has already exceeded the full-year total from 2019.
• The rally in risk assets allowed for a broader range of issuers to access the capital markets after March was dominated by A rated and above. For the quarter, BBB made up 47% of issuance, bringing year-to-date total of 43% versus 42% for all of 2019.
• As companies have sought to term out maturities, the resulting maturities for issuance this year have been longer compared to 2019. In the first half of 2020, the percentage of issuance longer than 13 years is 24% versus 22% for 2019; 6-12 years made up 40% of issuance this year versus 36% for 2019.
• Ratings actions continued to be negative in the second quarter with Standard & Poor’s up-to-down ratio in investment grade at 0.3 versus 0.49 in the first quarter and 1.8 in 2019. Fallen angel activity declined from $149 billion in the first quarter to just under $38 billion in the second quarter.

Portfolio Strategy

• The Fund had a positive return and outperformed the benchmark, driven largely by the decline in credit spreads. The Fund benefitted from incremental risk taken in the quarter.
• The Fund’s duration rose during the period and remains modestly under the benchmark’s duration of 8.28 years. Higher duration means higher price volatility for a given change in spreads as well as interest rates.
• The Fund increased its allocation to A rated securities, while decreasing its exposure to AA, BBB and BB rated securities.
• The largest changes in sector positioning were increases in the communications and basic materials sectors and decreases in the financial and consumer non-cyclical sectors.

Outlook

• The speed and scope of policy programs to halt the pandemic-driven economic decline supported risk assets in the quarter. However, the economic outlook is still fraught with risk. We are currently experiencing a pandemic, the likes of which we haven’t seen in more than 100 years, which resulted in a decline in gross domestic product which will likely be the largest in decades.
• Leverage in the investment grade market was near record levels coming into this crisis and the subsequent uptick in issuance and severe downdraft in earnings before interest, taxes, depreciation, and amortization (EBITDA) is likely to push this to unprecedented levels. Duration continues to increase in the investment-grade market, which presents incremental risk for investors. Since credit curves are upward sloping in aggregate (longer duration credit has higher spreads than shorter duration), more duration should result in more spread. Despite these factors, the current spread on the Bloomberg Barclays US Credit Index is 142 bps, which compares to the 20-year average of 158 bps. While stimulus continues to support market valuations, the current “average” spreads for what is clearly a period of higher than average risk, coupled with leverage and duration trends that are far worse than average, warrants risk reduction, which we have begun in the Fund.
• Fiscal and monetary stimulus may suppress index volatility going forward, but it is unlikely to stop downgrades and defaults, and thus cannot stop dispersion from occurring within the credit markets. For this reason, we believe the real value in the corporate credit market going forward doesn’t lie in betting on further index spread tightening, but rather in credit selection. Dispersion is being created within the markets as companies and industries are affected by and respond to the pandemic in vastly different fashions, which is an attractive environment for credit selection.
• Our team is continually focused on assessing the rapidly changing landscape to ensure our positioning optimizes the risk and reward for our investors.

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. Past performance is not a guarantee of future results.

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.

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 Portfolio's prospectus. Not all funds or fund classes may be offered at all broker/ dealers.