Market Sector Update

• The eventful first year of the new decade ended with vaccines developed and administered for a virus unknown a year earlier, but which dictated economic activity globally in 2020. U.S. election results remained in the headlines at year end as the outgoing administration continued to contest the validated results. The U.K. and European Union (EU) reached a trade agreement four and half years after the Brexit vote, just ahead of the transition deadline of December 31. China, having been first hit with the COVID-19 virus, was the first major economy to show signs of recovery before year end.
• The economic recovery lost steam as the fourth quarter began with surging COVID-19 infections and re-imposed restrictions. While economic data in the U.S. was solid, the pace of recovery slowed as initial jobless claims began to rise again and as Purchasing Managers Indicies slowed to a three-month low in December, most notably in the services sector. The U.S. Federal Reserve (Fed) kept its accommodative stance as the inflation remained well below its 2% target at 1.6%, committing to the current pace of asset purchases “until substantial further progress has been made toward the (FOMC) Committee’s maximum employment and price stability goals.”
• Spread markets continued to be well-supported in the fourth quarter. Developed market (DM) sovereigns in Europe benefitted from the roll-out of the economic relief package and the expanded European Central Bank (ECB) purchase programme. Central bank purchases provided technical support for DM corporates as well, with most sectors performing well over the quarter. The on-going search for yield led investors to begin rotating into the riskier sectors of credit, not just generally into high yield, but also into sectors still negatively impacted by the pandemic, such as travel/leisure and airlines.
• The U.S. dollar was weak over the quarter against both DM and emerging-market (EM) currencies, despite a brief election-related rally in November. The Swedish krona was strongest among the DM currencies, on better economic data and as the riksbank held interest rates and its balance sheet steady throughout the year, making the currency attractive from a relative monetary policy perspective.

Portfolio Strategy

• The Fund outperformed its cash benchmark over the quarter. Our Spread positions were the strongest contributors to performance. DM corporates performed very strongly across all sectors in both the U.S. and Europe. DM Sovereigns performed well with our long Italian government securities outperforming other peripherals. EM spread contributed positively to the portfolio performance, primarily from our hard currency sovereign positioning in commodity exporters in Latin America, Africa and Middle East/North Africa.
• Our Chinese property allocations contributed positively within our hard currency EM corporates. Within rates, our long U.S. duration was positive over the quarter with TIPS also performing well versus nominals. Our long German bund duration also contributed positively. Currency detracted as U.S. dollar weakness hurt our long U.S. dollar versus short EM currency. Our safe-haven longs in the euro and yen were positive, but our short British pound position detracted.
• Over the quarter, in rates, we increased our duration in the Dollar bloc, adding to our long U.S. duration as yields rose. We reduced our TIPs allocation profitably and reduced Australian duration in favor of Canada in intermediary maturities. In the eurozone, we reduced overall duration over the period by closing our inflation-linked position in France and our spread tightener in Spain but increased duration in intermediate maturity bunds.
• In spread, we continued to go down the capital structure of strong credits, increasing exposure to subordinated debt both in financials, such as insurance, and non-financials, but reduced where we felt valuations were tight. Within our energy holdings, we selectively rotated into renewables. In EM, we reduced our small tactical longs in the Dominican Republic and Costa Rica and increased in Oman.

Outlook

• Markets started 2021 with a heavy dose of optimism after the Democrats secured the majority in both chambers of the U.S. Congress, making it more likely that the Biden administration will be able to implement another fiscal stimulus package. We did not expect the Democratic victory in the Georgia run-off Senate election. We believe the rise in yields that followed was justified, given the improved prospects of a sizeable fiscal package in the U.S. Yet this rise in yields has also been accompanied by a rally in the U.S. dollar and some weakness in certain markets. It is concerning for us that at the same time that most of the western developed world is under lockdown, financial conditions seem to be tightening. That is why we have kept our long duration bias despite the potential fiscal stimulus.
• The Fed has reiterated that it will continue its current pace of asset purchases, but those have not been enough to contain the current rise in yields. We believe their current framework is quite backward-looking and it is unlikely that they will change path soon. As yields have risen, inflation expectations as measured by the difference between tenyear nominal and real yields from Treasury Inflations Protected Securities (TIPS) have risen over 2%. We believe this is overly optimistic and therefore have closed all of our TIPS positions in our portfolios. Given that inflation is currently around 1.5% and has been below 2% for more than a year, inflation would need to be above 2% for a very prolonged period of time to average 2% over the next ten years. U.S. core inflation has not had a ten-year average over 2% since 2011. Finally, we are quite glad that the U.S. dollar has so far worked well to diversify our long duration position and therefore are happy that we increased our U.S. dollar exposure as the consensus built up against it.

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 December 31, 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.

All information is based on Class I shares.

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. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

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.