As of 06-30-2018

Market Overview

For the three months ended June 30, 2018, the high-yield market outperformed the investment-grade bond market. For example, the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Bond Index (BBC2%HYBI) returned 1.03% versus a -0.16% return for the Bloomberg Barclays Aggregate Bond Index (Aggregate), a measure of high-quality bond performance.

The second quarter of 2018 marked the 10th consecutive quarter that the BBC2%HYBI outperformed the Aggregate. The quarter was marked by considerable volatility as yield spreads raced to cycle lows early in the period, retraced the tightening and peaked above beginning spread levels, made another run lower and then finished the quarter about where they began.  The volatility was driven by strong corporate earnings and the expectation of well above trend second quarter GDP growth on the positive side juxtaposed against the fears of what impact U.S. trade policy and tariffs would have on future earnings and future economic growth. 

High-yield credit fundamentals remained positive as strong earnings growth tempered default activity and limited new issue supply provided technical support. Broader economic indicators uniformly painted a picture of considerable economic momentum.  However, valuations to the rich side of historical levels provided little support when tariff rumors and pronouncements hit the tape.  For the quarter as a whole, the yield spread between the Credit Suisse High Yield Bond Index and Treasury securities with comparable maturities moved from 401 basis points at the beginning of the quarter to 399 basis points at quarter end after touching cycle lows of 354 basis points on April 18.

Within the high-yield market, the strongest-performing major industries relative to the BBC2%HYBI were: Pharmaceuticals, Oil Field Services, Independent Energy, Wireless Telecommunications and Cable & Satellite.  The worst-performing major industries relative to the BBC2%HYBI were:  Automotive, Banking, Building Materials, Consumer Products and Consumer Cyclical Services.  From a quality perspective, the credit-sensitive CCC-rated sector once again led the way with a 2.87% total return followed by the B-rated sector, which returned 1.42%.  The more interest-rate-sensitive BB-rated sector was the worst-performing quality sector with a -0.17% return.

Fund Performance

The fund underperformed the BBC2%HYBI. The fund was negatively impacted by an underweight in the strong-performing Oil Field Service and Wireline Telecommunications sectors and an overweight to the poor-performing Packaging sector.  The fund’s holdings in the Cable & Satellite and Independent Energy sectors also failed to keep pace with the benchmark.  While the fund was overweight the outperforming CCC-rated sector, the fund’s holdings in this quality sector tended to be in lower-beta CCCs while the strongest performers in the CCC category tended to be high-risk, high-beta securities.  Specific high-yield issuers held by the portfolio that negatively impacted performance relative to the BBC2%HYBI included:  Anna Merger Sub (aka Acosta), Community Health Systems, Bway Holdings, Telenet Finance Luxembourg and Ferrellgas.  Specific equity holdings that negatively impacted performance included: Clearwater Paper, Commscope and Owens Illinois.  The fund’s total return for the period also reflected actual cash flows, transaction costs and other expenses that were not reflected in the total return of the BBC2%HYBI.

The fund was positively impacted by security selection in the Automotive and Wireless industry sectors. The fund also benefited by its overweight to the strong-performing Pharmaceutical sector and its underweight to the poor-performing Banking sector.  Specific high-yield issuers held by the portfolio that positively impacted performance relative to the BBC2%HYBI included:  Valeant Pharmaceuticals, Mallinckrodt, Sprint, Endo Finance and PetSmart. Specific equity holdings that positively impacted performance included: B&G Foods, Hanesbrands and WPX Energy.

Past performance is no guarantee of future results.

Click on the Performance tab for standard fund performance.

Click on the Portfolio Characteristics tab for information on quality ratings and the fund’s top 10 holdings.

How We Are Positioned

We continue to believe that the ultimate low in credit spreads for this cycle is still ahead although that low will most likely not be materially lower than the 354 basis points registered on April 18. Considerable economic momentum, strong corporate earnings, positive event risk (mergers and IPOs) and limited new issue supply will be weighed against geopolitical issues, valuation levels and discussions about how long the current economic expansion can continue.  Excess returns for high-yield securities when compared to high-quality securities will result from a move to cycle low credit spreads coupled with the inherent yield advantage of high-yield bonds. We would also note that rising interest rates in general may temper absolute returns for all fixed-income securities.