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. Corporate Index, to fall slightly from 96 bps to 91 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. In the quarter, gross high-yield issuance was $150 billion, more than two times first quarter 2020 and up over 50% from fourth 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. In high yield, the ratio increased markedly from 0.8 in fourth quarter of 2020 to 1.52 in the first quarter of 2021. 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, however outperformed its benchmark. The Fund’s duration fell slightly during the period and remains moderately under the benchmark’s duration of 8.48 years. Higher duration means higher price volatility for a given change in spreads as well as interest rates.
• The Fund increased its allocation to BB and BBB rated securities, while decreasing its exposure to A and B rated securities. The largest changes in sector positioning were increases in the financial and consumer cyclical sectors and decreases in the consumer non-cyclical and communications 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 are likely to persist and prevent a meaningful rise in longer term inflation.
• 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 12 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 approximately 11 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.
• Credit fundamentals are likely to improve and result in deleveraging on balance for corporate credit, but fundamentals will continue to be weak, with leverage remaining near record highs and investment grade duration near a record high. Despite this, credit spreads sit at 91 bps for investment grade, well below their 20-year average of 156 bps. Similarly, high yield spreads of 310 bps versus their long-term average of 538 bps do not seem congruent with a default rate of 5.4%. Default trends have improved from the 6.8% rate we saw at the end of 2020, however they remain well above their long-term average of 3.4%. Layer on the fact that recovery rates after default sit at near-record lows and that upside is constrained by most of the high-yield market trading above its call price.
• We continue to believe there is significant excess risk taking in the market. 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. Supply remains manageable and demand from insurance, pensions and foreign investors is being driven by rising hedged yields.
• Going forward, we expect frequent periods of volatility and spreads not to rally 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 continue to expect many mispriced credit situations as various industries, geographies and companies will respond differently 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 Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market and includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers. It is not possible to invest directly in an index.

All information is based on Class I shares.

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. Fixed income securities in which the Fund may invest are subject to credit risk, such that an issuer may not make payments when due or default or that the risk that an issuer could suffer adverse changes in its financial condition that could lower the credit quality of a security that could affect the Fund’s performance. A rise in interest rates may cause a decline in the value of the Fund’s securities, especially securities with longer maturities. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Investing in foreign securities involves a number of economic, financial, legal, and political considerations that are not associated with the U.S. markets and that could affect the Fund’s performance unfavorably, depending upon the prevailing conditions at any given time. Mortgage-backed and asset-backed securities in which the Fund may invest are subject to prepayment risk and extension risk. The Fund typically holds a limited number of fixed income securities (generally 40 to 70). As a result, the appreciation or depreciation of any one security held by the Fund may have a greater impact on the Fund’s NAV than it would if the Fund invested in a larger number of securities. Fund performance is primarily dependent on the management company’s skill in evaluating and managing the Fund’s portfolio. There can be no guarantee that its decisions will produce the desired results. 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.