Market Sector Update

• High yield spreads came under pressure in the fourth quarter amid signs of slowing growth in China and Europe, sharp declines in oil and other commodity prices, the weakest December equity market performance since the Great Depression and a disappointing Federal Reserve (Fed) meeting that offered no flexibility with respect to the balance sheet runoff.
• Treasury rates traded lower across all maturities on the curve – 5- and 10-year treasury rates decreased by 44 and 38 basis points (bps), respectively, during the quarter.
• The option-adjusted spread (OAS) on the Fund’s benchmark started the quarter at 316 bps and widened to 526 bps at the end of December.
• New issue supply remained subdued as only $19 billion priced which is historically low for the quarter. Retail fund flows were sharply negative during the quarter with $20.2 billion exiting, according to AMG data. The high yield market remains significantly undersupplied.

Portfolio Strategy

• The Fund underperformed its prospectus benchmark due to security and sector selection.
• Security selection was the main reason for underperformance during the quarter with sector selection having a relatively small impact. From a security selection standpoint, the most notable detractors came from holdings in the communications, finance company and basic industry sectors. These detractors more than offset contributions from holdings in the energy sector.
• From a sector selection standpoint, the Fund benefitted from a cash position and an overweight allocation to real estate investment trusts (REITs). However, these contributions were more than offset by the impact of underweight allocations to banking, consumer non-cyclical and electric utility names.
• Security selection has been the major source of underperformance given our preference for less appreciated issuers where we can underwrite the underlying story, though the preference for the single-B rating tier and more cyclical sectors was also a drag.

Outlook

• Credit fundamentals remain relatively unchanged away from basics, cyclicals and energy. Current spreads across non-investment grade credit imply a rise in defaults to 4%. We believe this is a level that will get visited on the way to a recession, therefore positioning requires a view on near term recession probability. Our opinion remains in the ‘no recession’ camp implying that the asset class is reasonably inexpensive at current valuations.
• We remain of the view that 2019 recession probability remains low. If this view holds, BB pricing may struggle to stay unchanged during 2019 as 10-year Treasury yields may move back to the 3.00-3.25% area.
• We believe volatility induced by the unpredictable U.S. administration and U.S.-China trade talks likely remains a facet of markets for the foreseeable future, but current risk aversion is rooted in a necessary repricing of equity multiples lower as earnings growth slows to a high single-digit rate. Therefore, we are maintaining our current positioning despite short-term underperformance.
• We would change our view based on fourth quarter earnings commentary from our coverage universe, hawkish central bank movement, especially the Fed; and we continue to monitor movements in money markets and the yield curve for clues.

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 Dec. 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.

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. 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. 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.