Market Sector Update

• High-yield bonds began recovering in April as dramatic monetary and fiscal actions to combat economic shocks caused by the outbreak of COVID-19 renewed investor confidence. In March, the Federal Reserve (Fed) reduced rates 150 basis points (bps) via two rate cuts, bringing the federal funds target range to 0-0.25%. It rolled out additional initiatives to guarantee liquidity to the primary and secondary investment-grade credit markets, while Congress passed a $2 trillion relief package.
• On top of the actions taken in March, the Fed expanded its bond buying program on April 9 to include fallen angels as well as high-yield exchange-traded funds (ETF), with an aim to ensure credit markets are able to support businesses that are otherwise fundamentally sound. This helped lead to a pick-up in issuance of high-yield bonds, though primarily in the senior secured format.
• The recovery continued in May as investor confidence improved further on the back of consistent monetary and fiscal support and anticipation of an imminent reopening of economies as most developed market countries moved past peak infection. The Fed’s facilities made initial purchases in credit and oil prices rebounded. Volatility also declined despite risk concerns as investors contended with the reescalation of U.S.-China trade tensions and record unemployment levels.
• The pace of the recovery slowed in June as investors weighed improving economic reports, against increasing COVID-19 infections. Technical conditions remained supportive as a deluge of new-issue activity was met with record retail inflows alongside the start of the Fed’s ETF buying program.
• The par-weighted default rate increased significantly during the quarter, jumping to 6.19%, which is 356 bps higher year-to-date and 473 bps higher over the last 12 months. The default rate has not reached this level since March 2010. The energy sector was responsible for a significant portion of defaults, bringing the par-weighted default rate exenergy to a more moderate 4.21%.
• The 5- and 10-year Treasury rates were range bound during the quarter, trading 9 bps and 1 bp lower, respectively. The option-adjusted spread on the Bloomberg Barclays US HY Index traded 254 bps tighter to end at 626 bps.
• High-yield mutual funds and ETFs reported inflows of $47.3 billion in the quarter – April and May were the top two monthly inflows on record and June as the fourth largest. This follows outflows of $11.7 billion in March, which was the third largest monthly outflow on record.
• Gross new issue activity totaled $145.5 billion and net issuance totaled $75.5 billion during the quarter, easily surpassing prior gross and net issuance records of $121.2 billion in second quarter of 2014 and $52.6 billion in first quarter of 2015, respectively.

Portfolio Strategy

• According to Barclay’s data, Ba-rated bonds returned 11.54%, while single-B rated bonds returned 8.64%, and Caarated bonds returned 9.10%.
• The Fund underperformecd the benchmark for the quarter. Sector selection detracted from performance, while security selection contributed.
• From a sector selection standpoint, an underweight allocation to the energy sector was the primary detractor, while the Fund’s cash position dragged on performance. These detractions more than offset contributions from underweight allocations to the consumer non-cyclical and capitals goods sectors.
• From a security selection standpoint, holdings in the consumer cyclical and technology sectors were the largest contributors, while energy holdings detracted.

Outlook

• Certain U.S. economic reports have come in better than anticipated in June, spurring optimism. Most notably, nonfarm employment rose by 2.5 million leading to a downtick in the unemployment rate. Both ISM manufacturing and non-manufacturing surveys moved up in May and most recently, investors saw a much stronger than expected 17.7% surge in U.S. retail sales. However, it is important to note that these indicators are rebounding from very low levels. The nation’s unemployment rate remains at 13.3%, both ISM surveys remain below their expansionary threshold of 50 and retail sales are still far below last year’s levels.
• High-yield bond prices have continued to rise as investors focus on more stimulus and recent economic data supporting the view that activity has bottomed and may ultimately recover. Technical conditions in high yield remain supportive as the asset class continues to see record inflows into mutual fund and ETF vehicles. This has enabled a deluge of new issuance as companies sought to bolster liquidity. Supply is running about 75% higher than this time last year. Credit spreads have tightened dramatically relative to March’s widening; however, we see the potential for further tightening as the Fed’s announcement to initiate index-based corporate bond purchases may likely result in strong demand.
• While we find a majority of credit markets attractive on an intermediate-term basis, we are particularly bullish on the high-yield market, which we believe stands to benefit from more favorable technical demand due to retail inflows, direct Fed support and fallen-angel issuers entering the market and trading at attractive levels. Moreover, with increased dispersion, we are seeing idiosyncratic security selection opportunities. With that said, we remain cognizant of the many recovery-derailing risks that remain, including a second wave of infections, a fiscal cliff if states or the federal government withdraw stimulus too early, a deteriorating U.S.-China relationship over COVID-19 damage claims, and the upcoming U.S. presidential election.

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 June 30, 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.

The Bloomberg Barclays U.S. Corporate High-Yield Index measures the U.S. dollar-denominated, high-yield, fixed-rate corporate bond market. It is not possible to invest directly in an index.

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. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. 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. 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.