Market Sector Update

• The first quarter saw a continued recovery in risk assets as anticipation of a growth inflection due to reopening and further stimulus measures resulted in domestic equities rallying more than 6%.
• The positive news and sentiment drove U.S. Treasury yields dramatically higher in the period. The yield on the 10-year U.S. Treasury rose 83 basis points (bps) to 1.74%, while the yield on the 2-year U.S. Treasury rose 4 bps to 0.16%. During the quarter, the yield curve steepened significantly as the difference between the 10-year U.S. Treasury and the 2-year U.S. Treasury rose 79 bps to 158 bps.
• The positive risk sentiment in the quarter led to the spread on the Fund’s benchmark, the Bloomberg Barclays U.S. Credit Index, falling slightly from 92 bps to 86 bps. High yield gained 0.85% as the spread on the Bloomberg Barclays U.S. Corporate High Yield Index fell from 360 bps to 310 bps, while leveraged loans gained 2% as their low duration helped support the asset class relative to investment grade and high yield.
• Investment-grade gross issuance fell 3% from the first quarter of 2020, to $524 billion as heavy issuance throughout 2020 bolstered balance sheets and allowed for ample refinancing of existing debt. Issuance net of maturities fell 18% to $217 billion this quarter versus $264 billion of net issuance in first quarter 2020.
• Ratings actions improved in the first quarter with Standard & Poor’s upgrade-to-downgrade ratio in investment grade at 0.57 versus 0.33 in the fourth quarter of 2020 and 1.23 for 2019. Fallen angel activity decreased markedly to $1.2 billion in the quarter from roughly $23 billion in the fourth quarter of 2020.

Portfolio Strategy

• The Fund had a negative return but outperformed its benchmark.
• The Fund’s duration rose during the period. After having been moderately under the benchmark’s duration, it is now close to the benchmark’s duration of 8.23 years. Higher duration means higher price volatility for a given change in spreads as well as interest rates.
• The Fund increased its allocation to BBB and BB rated securities, while decreasing its exposure to A and AA rated securities.
• The largest changes in sector positioning were increases in the technology and industrial sectors and decreases in the financial and consumer non-cyclical sectors.

Outlook

• As we entered 2021 it became clear that this year will be one of extremely robust growth as the reopening of the economy coincides with massive fiscal and monetary stimulus. Additionally, markets have priced in the presumption that excess savings accumulated during the pandemic will be spent. This has resulted in a significant rise in yields as growth and inflation expectations have risen.
• Going forward the principal question is: of the recent increase in growth and inflation expectations, how much will be durable versus transitory? We believe that much of the growth expected this year will be transitory. While we think inflation will certainly remain higher than it was this past year, the secular trends keeping inflation low, such as technology and demographics, are likely to persist and prevent a meaningful rise in longer term inflation.
• Last year saw a historically high level of uncertainty as individuals, companies and governments grappled with a once-in-one-hundred-year pandemic. We believe uncertainty will remain high. This year we’ve already seen significant issues with supply chains and uncertainty over the reopening, regulatory, fiscal and monetary policy, which is likely to persist for the remainder of the year.
• While credit spreads have modestly tightened this year, the tightening hasn’t been linear and we’ve experienced some volatility in spreads. Between mid-February and mid-March, credit spreads on the benchmark widened 11 bps on supply, volatility and rising U.S. Treasury yields. The breakeven spread, meaning the level of spread widening that wipes out a full year of spread carry is just over 10 bps, a level we’ve already exceeded within the first quarter. For the remainder of the year we see the potential for such volatility to persist due to weak credit fundamentals, an uncertain outlook as well as the potential for higher issuance and re-leveraging events.
• We think investment-grade fundamentals are likely to improve as substantial earnings before interest, taxes, depreciation, and amortization (EBITDA) and cash-flow growth will result in deleveraging on balance for the investment grade marketplace. Overall, however, we think fundamentals will continue to be weak, with leverage remaining near record highs and duration in the market being near a record high. Despite this, credit spreads sit at 86 bps for investment grade, well below their 20-year average of 145 bps.
• We continue to believe there is significant excess risk taking in the marketplace and it is during these times of euphoria that credit markets become impacted by increases in financial engineering and mergers and acquisitions (M&A). Lagging equities likely feel obliged either under their own volition or under pressure of activists to borrow at low rates to repurchase stock, pay dividends or embark on M&A. Such activity impacts specific credits and has macro implications by creating an increased risk premium for re-leveraging conditions, as well worsening the supply and demand technicals.
• The technical backdrop continued to be supportive and is likely in our view, to persist for some time. Fund flows have weakened recently but still surpass what many would have predicted given the negative asset class returns year to date. Weaker flows are counterbalanced by supply which remains manageable and increasing levels of foreign demand driven by rising hedged yields available in the US as well as incremental demand from insurance, pension and other participants attracted to higher overall yields.
• Going forward, we believe that poor fundamentals and valuations for investment grade, continued uncertainty in economies, as well as the potential for an increase in shareholder friendly activity, will result in frequent periods of volatility and prevent spreads from rallying materially in the coming year. Our conservative positioning is designed to allow us to opportunistically take incremental risk to capitalize on the volatility as it presents itself. In environments like these the cost of being defensive is very low.
• We believe credit selection will continue to be paramount as the pandemic hopefully recedes and economies reopen. We continue to expect many mispriced credit situations as various industries, geographies and companies will differ dramatically in how they are affected by and respond to the reopening, as well as the evolving monetary and fiscal policy going forward.

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. 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.

Bloomberg Barclays U.S. Corporate High-Yield Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. 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.