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.
• During the quarter, high yield had a strong return of more than 7% as spreads tightened from 522 to 391 basis points (bps). Leveraged loans rallied to return more than 3.7%, 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%.
• High yield trends are slightly better than the investment grade market. Overall, the high yield sector was down to four-times levered in the high yield sector during fourth quarter of 2018. This was driven by decreasing leverage in the lower-levered quartile of high yield. However, this was offset by the increasing leverage in the higher-levered quartile, which we view as a sign of caution since these companies typically drive the majority of defaults.
• 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.
• Issuance in the high yield market was $66 billion in the quarter, down 10% compared to the first quarter of 2018.

Portfolio Strategy

• The Fund had a positive return and outperformed its benchmark, the Bloomberg Barclays U.S. Corporate Index. The benchmark returned roughly 5%, which was driven by falling rates and the spread on the benchmark declining from 152 bps to 119 bps. Duration of the benchmark rose 0.3 year to 7.4 years at the end of the quarter.
• During the quarter, the Fund further reduced its duration relative to the benchmark by bringing duration from roughly 0.5 year shorter to approximately one year shorter.
• The overall risk of the Fund, as measured by its spread relative to the benchmark, decreased moderately in the quarter. The Fund’s spread remains above the benchmark due to its exposure to the high-yield market, which is not a material component of the benchmark.
• The Fund made modest changes to overall risk. The Fund reduced its BB weighting relative to the benchmark and increased its BBB exposure.
• The largest changes in sector positioning were increases in the energy and utilities sectors and decreases in the consumer non-cyclical and industrial 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. Higher duration means higher price volatility for a given change in spreads.
• 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.
• 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 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. 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.

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 30 to 50). 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.