Market Sector Update

• High yield spreads traded tighter through the first three weeks of October and then wider during the last week of the month, trading roughly flat overall. Capital market activity slowed somewhat following back-to-back $50-billionplus volumes in August and September. Reduced new-issue activity, coupled with inflows into retail mutual funds and exchange traded funds (ETFs), created a strong technical backdrop for the high yield market.
• Investors had to contend with uncertainty related to the U.S. election, additional fiscal stimulus in the U.S., the rapid rise in COVID-19 cases in the U.S. and Europe, and the increasing the risk of governments reinstituting varying degrees of shutdown measures and pushing economies around the globe back into recession. High yield spreads then traded tighter in November and December as clarity around the results of the U.S. presidential election, positive news flow on vaccine development and distribution, and ongoing optimism and passing of additional fiscal stimulus provided confidence of a stronger recovery in 2021. The boost in investor optimism came despite the continued surge in COVID- 19 infections in the U.S. and Europe. In the meantime, central banks continue to provide support and have indicated that their accommodative measures will remain in place for the foreseeable future, keeping rates lower for longer.
• Gross new issue activity totaled $99.6 billion during the quarter, down from second and third quarter levels, but still the ninth highest total quarterly issuance on record. Full-year issuance totaled $449.9 billion, up 57% from 2019 levels and surpassing the prior record issuance of $398.5 billion in 2013. High yield mutual funds and ETFs reported inflows of $8.3 billion in the fourth quarter. For 2020, high yield funds reported inflows of $44.3 billion, up from 2019 inflows of $18.8 billion. The par-weighted U.S. high yield default rate ended December at 6.17%, which is 353 basis points (bps) higher than the start of the year and significantly higher than the long-term average of approximately 3.5%.
• The 5- and 10-year U.S. Treasury rates traded 8 bps and 23 bps higher, respectively. The option-adjusted spread (OAS) on the Bloomberg Barclays U.S. Corporate High-Yield Bond traded 157 bps tighter during the quarter to end at 360 bps. The U.S. dollar weakened during the quarter, decreasing 4.21%.

Portfolio Strategy

• The Fund had a positive mid-single digit return, but underperformed its benchmark.
• From a sector selection standpoint, the cash position and an overweight allocation to the electric sector were the largest detractors, while overweight allocations to the finance companies, transportation and energy sectors contributed to performance.
• From a security selection standpoint, holdings in the energy and real estate investments trusts (REIT) sectors were the most notable detractors, while holdings among consumer cyclical and communications names contributed.
• According to Barclay’s data, Ba-rated bonds returned 5.69%, while single-B rated bonds returned 5.83% and Caarated bonds returned 9.91%.

Outlook

• High yield bonds rallied further in December with spreads approaching levels not seen since the beginning of the year. Overall index spread levels have now largely closed the gap with what would normally be considered fair valuations against the current default backdrop. However, we see the potential for credit markets to tighten further.
• The results of the Georgia Senate runoff election are now known, with the Democrats winning both seats, resulting in unified control of the U.S. Presidency and both chambers of Congress, albeit with slim majorities. As a result, we now expect to see a more robust fiscal package than we anticipated in previous months when a divided government appeared to be the most likely outcome, which should further boost market sentiment.
• Technical conditions remain supportive, with robust institutional and retail demand for high yield bonds as investors search for yield. Moreover, we expect the lowering of risk premia to continue into 2021 and beyond, as Federal Reserve policy remains accommodative and has diminished tail risks for investors.
• While we remain cognizant of the risks still present in the market, such as high rates of COVID-19 infections and the emergence of virus mutations threatening new shutdown measures, we believe these issues will ultimately be outweighed by the various tailwinds supporting financial markets. Against this backdrop, we remain constructive on the high yield bond market and continue to seek to add incremental returns at the issuer and security selection level.

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, 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.