Market Sector Update

• Most fixed income asset classes experienced positive total returns during the third quarter, despite volatility in equity and treasury markets. The dovish stance of central banks globally continued amid concerns around global growth, particularly in the eurozone, Brexit uncertainty, and risks of trade war escalation between the U.S. and China.
• In August, investors saw a reescalation of U.S.-China trade tensions as President Donald Trump announced the U.S. would impose a 10% tariff on $300 billion worth of Chinese imports in addition to the 25% tariff already imposed on $250 billion of Chinese goods. Subsequently, the Office of the U.S. Trade Representative announced that various items would be excluded until mid-December.
• The Federal Reserve made anticipated 25 basis point (bps) cuts in both July and September, although it did not make substantive changes to the statement language leaving uncertainty around future meetings. The European Central Bank also cut rates in September, moving further into negative territory, and announced a new quantitative easing program starting in November in which it will buy $20 billion worth of bonds a month.
• Geopolitical tensions heightened after mid-September’s drone attacks on two Saudi Arabian oil facilities, affecting 5% of the global oil supply. This resulted in WTI crude oil prices surging $8 on Sept. 16; however, the increase ultimately unwound by month end. Overall, energy remained a laggard in the high yield market.
• Treasury rates continued to trade lower during the quarter, with 5- and 10-year Treasury yields trading 22 and 34 bps lower, respectively. Investors also saw a lot of volatility in the high yield market during the quarter. The spread on the Bloomberg Barclays U.S. Corporate High Yield Index ended the quarter at 373 bps, trading just 4 bps tighter overall; however, the OAS traded as tight as 355 bps and as wide as 444 bps during the quarter.
• High yield funds saw inflows in July and September, but outflows in August, only the second such occurrence of 2019. High yield funds reported $2.8 billion of inflows in the quarter, and inflows of $15.3 billion year-to-date. During the quarter, gross new issue activity totaled $67.7 billion, with September producing the heaviest monthly volume ($31.3 billion) since September 2017 as issuers took advantage of the sharply lower yield environment.

Portfolio Strategy

• The Fund had a low-single-digit return for the quarter, but underperformed its benchmark.
• Security selection detracted during the quarter, while sector selection contributed. From a security selection standpoint, credit selection among energy names was the largest detractor, while holdings in the technology sector were the most notable contributor. From a sector selection standpoint, an underweight allocation to the energy sector and an overweight allocation to REITs contributed to performance, more than offsetting detractions from underweight allocations to the consumer cyclical and banking sectors.
• Higher quality bonds outperformed lower quality bonds, on average, during the quarter. Ba-rated bonds returned 2.03%, while single-B rated bonds returned 1.65% and Caa-rated bonds returned -1.76%.

Outlook

• Earnings season resulted in flat sales, low-single-digit earnings, higher margins, marginally higher leverage and lower capex. We believe the next two quarters portend more of the same before earnings move higher in the first quarter of 2020. However, estimates are for a relatively sharp rebound in the face of the same list of macro issues (trade war, Brexit, etc.).
• Valuations appear tight to fairly valued dependent on the macro view, and 2020 earnings growth estimates need to be realized to justify valuations at these levels. With that said, we still see a decent number of discounted names as the BBB/BB trade remains crowded. Moving forward, fallen angels and 2020-2023 maturities in energy, and a bulge of issuance in health care and technology remain areas to watch.
• We have seen hints of economic deterioration in the U.S., with the most recent Institute for Supply Management (ISM) Purchasing Managers Index reporting the second consecutive month of contraction, and the ISM nonmanufacturing index falling to its lowest level since August 2016.
• We moderately increased default rate assumptions, but still see few issues in the asset class. As such, we believe we will continue to see increased volatility in the near term and favor the relative safety of being up the capital structure or holding higher cash balances, maintaining the flexibility to shift into areas that become dislocated from intrinsic value.

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 Sept. 30, 2019, 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.

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.