Market Sector Update

• The recovery in high yield bond prices reaccelerated in July amid ongoing accommodative monetary policy in the U.S. and globally, better than expected earnings, positive news around vaccine and treatment development, and progress on another fiscal relief package. Technical conditions also remained supportive as an active new issue market was met with continued high levels of retail inflows alongside the Fed’s ETF buying program. Spreads on high yield bonds were trading at their tightest levels since early March despite the continual spread of COVID-19 and risks related to the U.S. presidential election, a deteriorating relationship between the U.S. and China, and Brexit.
• High yield bond prices continued to rise in August, although at a slower pace, as investors remained focused on second quarter revenue and earnings that beat expectations, further vaccine progress and the global economic revival. Issuance was again a major driver as a busy calendar – driven, in part, by borrowers choosing secured bond deals instead of loans – was combined with moderating demand from retail funds.
• September saw a decline in high yield bond prices and widening spreads due to increased uncertainty around additional U.S. fiscal stimulus, a renewed surge of COVID-19 infections in Europe, U.S. political uncertainty and Brexit. That said, central banks continue to support markets with rates held steady at extremely low levels. Meanwhile, technical conditions dragged on the asset class as another month of heavy issuance was met by the first month of fund outflows since March.
• Gross new issue activity totaled $131.9 billion during the quarter, down from second quarter levels, but still the second highest total quarterly issuance on record. Year-to-date issuance is now over $350 billion, and is on pace to surpass record annual issuance of $398.5 billion in 2013.
• High yield mutual funds and ETFs reported inflows of $10.7 billion in the quarter, down from record inflows in the second quarter. This comes despite outflows of $4.3 billion in September, with the vast majority coming during the last week of the month. The par-weighted U.S. high yield default rate, including distressed exchanges, ended September at 6.36%, which is 356 basis points (bps) higher over the last 12 months.
• The 5- and 10-year U.S. Treasury rates traded 1 bp lower and 3 bps higher, respectively. The option-adjusted spread (OAS) on the Bloomberg Barclays U.S. Corporate High-Yield Index traded 109 bps tighter during the quarter to end at 517 bps.

Portfolio Strategy

• The Fund marginally underperformed its benchmark. Sector selection detracted from performance during the quarter, while security selection contributed.
• From a sector selection standpoint, underweight allocations to the energy and consumer cyclical sectors were the largest detractors, more than offsetting contributions from overweight allocations to the transportation and brokerage, asset managers and exchanges sectors.
• From a security selection standpoint, holdings in the consumer cyclical, technology and real estate investment trusts (REITs) sectors were the most notable contributors, while holdings among energy, capital goods and consumer noncyclical names detracted.
• Ba-rated bonds returned 4.02%, while single-B rated bonds returned 4.53% and Caa-rated bonds returned 7.35%, according to Barclays data.

Outlook

• High yield bonds were relatively resilient despite renewed stock market volatility, but finally came under pressure amid concerns about a drop in oil prices and the possibility of new restrictions to curb the spread of COVID-19.
• While fiscal policy support in the U.S. has run out and is unlikely to resume until after the U.S. elections, accommodative monetary policy continues and has been strong enough for investors to look past the current uncertainty.
• While a number of considerations could derail the timeline for fundamentals to catch up to investor expectations, such as significant increases in Covid-19 cases, the U.S. election and Brexit, we expect spreads to continue to grind tighter amid strong technical support as we expect to see continued strong demand and a slowdown in issuance.
• While we remain constructive on the asset class, we maintain a moderate posture from an overall risk standpoint, and we are looking for individual credit selections to drive overall performance.

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, 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.