Market Sector Update

• 2018 started with a sharp selloff in the U.S. Treasury market. Solid growth data, higher inflation and the U.S. Treasury announcing larger-than-estimated borrowing needs for the first half of 2018 sent US 10-year yields 50 basis points higher over the first two months. However, rates retracted in March after a “dovish” 25 basis points rate hike by the Federal Reserve (Fed). While the Federal Open Market Committee members were more upbeat with economic outlook and revised up median dots for 2019 and 2020, Fed Chair Powell struck a dovish tone at his first press conference and downplayed the importance of the Fed “dots”. Also supporting the Treasury market was the safe-haven demand as concerns about protectionism and the IT sector have kept the stock market under pressure. Overall, the U.S. curve flattened in the first quarter with higher yields across the curve.
• The German curve also flattened in the first quarter, with 10-year Bund yields rising by 10 basis points, while 30-year yields declined by a similar magnitude. Data momentum has softened in the Eurozone after a solid January. Albeit still at high levels, both PMIs and confidence indicators declined in the first quarter. The European Central Bank dropped its easing bias at the March meeting and raised its growth forecast for 2018. However, the inflation forecast was left unchanged for this year and was revised slightly down for 2019. 10-year Bund yields rose 30 basis points in January, only to be retracted by two-thirds in the rest of the quarter.
• In other developed markets, the Bank of Canada hiked rates by 25 basis points to 1.25% in January. It retained its data dependency and communicated its cautiousness about future hikes. The Bank of England voted seven to two to leave monetary policy unchanged in March and conveyed a hawkish tone, leaving room for a May hike. The Bank of Japan also left monetary policy unchanged in March and provided a positive assessment of the economy.

Portfolio Strategy

• The portfolio underperformed its cash benchmark in the first quarter. Our rates positions had a positive contribution to the portfolio in the first quarter, thanks to the consolidation in rates in March. Our spreads positions detracted from performance, with most of the loss occurring in March from our European subordinated bank corporate holdings. The contribution from our Forex positions was negative in the quarter, mainly coming from the underperformance of the U.S. dollar vs. the South African rand and the Colombian peso.
• In rates, we increased duration in the intermediate U.S. sector, where we believe the markets have almost fully priced the main Fed scenario - three hikes in 2018 and two more in 2019. We reduced our overweight in the long-end of the U.S. curve, as we think the curve is unlikely to flatten further, given the Treasury supply/demand dynamics and mediumterm inflation uncertainty associated with the budget and weak U.S. dollar. We added to the long-end of the German curve, as we continue to believe markets are too optimistic about the potential terminal deposit rate from the European Central Bank.

Outlook

• After the first quarter of 2018 we have a murkier picture of the world economy than what we had at the beginning of the year. The year started with resounding optimism as growth, earnings and fiscal easing supported risk assets and sent rates higher. The underlying growth picture and tame inflation remain supportive of risky assets. But the headlines emanating from the leadership of the three largest military powers in the world is concerning. Diplomatic tensions, trade wars and concentration of power around a few are a challenge to the “Great Moderation” framework of democracy, open markets and relative peace endorsed by most of the world over the last 40 years. Over the course of the last few years, those threats and tensions have presented opportunities in the market to add risk mainly because the threats have not materialized into lower trade, or direct armed conflict. Those remain in our view risks but not central scenarios. We do not claim to have an edge in forecasting these highly volatile political headlines but we do know that we need to get used to them rattling markets and correlations from time to time. Our inclination will be then to favor the still strong economic backdrop over the comings and goings of the political headlines while actively managing our tail risks.

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 Mar. 31, 2018, 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.

Diversification does not guarantee a profit or protect against loss in a declining market. It is a method to manage risk.

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. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. 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, 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. The Fund may seek to manage exposure to various foreign currencies, which may involve additional risks. The value of securities, as measured in U.S. dollars, may be unfavorably affected by changes in foreign currency exchange rates or exchange control regulations. Investing in foreign securities involves a number of risks that may not be associated with the U.S. markets and that could affect the Fund's performance unfavorably, such as greater price volatility; comparatively weak supervision and regulation of securities exchanges, fluctuation in foreign currency exchange rates and related conversion costs, adverse foreign tax consequences, or different and/or less stringent financial reporting standards. Mortgage-backed and asset-backed securities in which the Fund may invest are subject to prepayment risk and extension risk. The Fund employs investment management techniques that differ from those often used by traditional bond funds, including a targeted return strategy, and may not always perform in line with the performance of the bond markets. The Fund is also non-diversified and may hold fewer securities than other funds and a decline in the value of these holdings would cause the Fund's overall value to decline to a greater degree than a more diversified fund. The Fund expects to use derivatives in pursuing its investment objective. The use of derivatives presents several risks including the risk that fluctuation in the values of the derivatives may not correlate perfectly with the overall securities markets or with the underlying asset from which the derivative's value is derived. Moreover, some derivatives are more sensitive to interest rate changes and market fluctuations than others, and the risk of loss may be greater than if the derivative technique(s) had not been used. These and other risks are more fully described in the Fund's prospectus.