As of 09-30-2018

Market Overview

For the three months ended September 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 2.40% versus a 0.02% return for the Bloomberg Barclays Aggregate Bond Index (Aggregate), a measure of high-quality bond performance.

The third quarter of 2018 marked the 11th consecutive quarter that the BBC2%HYBI outperformed the Aggregate. The main reason for the strong performance in the high-yield market was the strong earnings growth by U.S. corporations driven by regulatory reform, tax reform, strong labor markets, rising consumer confidence and healthy business confidence. The high-yield market also benefitted from modest net new issuance during the quarter and strong returns in the equity markets. While holders of risk assets continue to be concerned by rhetoric on tariffs and trade wars as well as the Federal Reserve’s policy action to push short rates higher, the strength in earnings seemed to outweigh these concerns. 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 399 basis points at the beginning of the quarter to 360 basis points at quarter end.

Within the high-yield market, the strongest-performing major industries relative to the BBC2%HYBI were: Pharmaceuticals, Wireless Telecommunications, Cable & Satellite, Transportation Services and Health Care. The worst-performing major industries relative to the BBC2%HYBI were: Retail, Automotive, Home Construction, Building Materials and Independent Energy. From a quality perspective, the credit-sensitive CCC-rated sector once again led the way with a 2.73% total return followed by the BB and B-rated sectors, which returned 2.32% and 2.29%, respectively.

Fund Performance

The fund modestly underperformed the BBC2%HYBI on a net basis and outperformed on a gross basis. The fund was positively impacted by its overweight to the strong-performing Pharmaceutical and Cable & Satellite industry sectors as well as strong security selection in these sectors. Strong security selection in the Retail and Finance Companies industry sectors also benefitted performance. The fund’s underweight to the weak-performing Home Construction sector was a positive contributor to performance. The fund’s duration positioning versus the benchmark also was a positive contributor given the rise in interest rates. Specific high-yield issuers held by the portfolio that positively impacted performance relative to the BBC2%HYBI included: Mallinckrodt, Virgin Media, Endo Finance, Park Aerospace and Match Group.

The fund was negatively impacted by poor security selection in the Food & Beverage and Independent Energy industry sectors. The fund’s overweight to the underperforming Packaging sector negatively impacted performance. Specific high-yield issuers held by the portfolio that negatively impacted performance relative to the BBC2%HYBI included: Anna Merger Sub (aka Acosta), Ultra Resources, Hillman, Ferrellgas and SRC Energy. 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.

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

Credit spreads ended the quarter marginally higher than the cycle lows of 354 basis points registered on April 18, 2018. Spreads are being driven by the strong macroeconomic environment and strong corporate credit fundamentals. While we believe the lows in credit spreads are still to come for this cycle, we believe they may not be substantially lower than current levels. Excess returns for high-yield securities will be driven by the move to lower credit spreads and attractive income carry implicit in high-yield securities. While total returns relative to other fixed-income instruments may be attractive, rising interest rates may temper absolute returns in this environment. Default rates should remain low for the intermediate term as recessionary conditions are unlikely over this time frame although trade tensions and the impact from high interest rates may cause some concern.