As of 09-30-2017

Market Overview

For the three months ended September 30, 2017, 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 1.98% versus a 0.85% return for the Bloomberg Barclays Aggregate Bond Index, a measure of high-quality bond performance.

High-yield bonds continued to deliver attractive returns on both an absolute and relative basis during the third quarter. A number of factors contributed to the strong performance.  First, it appears that a global synchronized economic expansion has taken hold with the U.S., Europe and China all showing positive economic performance.  While not robust, the slow and steady pace of economic activity was very soothing to markets.  In this environment, corporate credit quality remained strong as default rates moved lower, leveraging of balance sheets remained at acceptable levels, interest coverage remained high and cash flow generation remained robust.  Recognizing these factors, equity markets moved to new highs providing supporting evidence of corporate health.  Although the quarter was not without its challenges–hurricanes Harvey and Irma, inflamed rhetoric relating to the Korean peninsula and political policy uncertainty–economic conditions seemed to carry the day “trumping” all else.  The overall impact of these factors can be seen in the decline in the yield spread between the Credit Suisse High Yield Bond Index and Treasury securities with comparable maturities which tightened from 428 basis points to 402 basis points during the quarter.

Within the high-yield market, the strongest-performing major industries relative to the BBC2%HYBI were Oil Field Services, Transportation Services, Independent Energy, Pharmaceuticals and Metals. The worst-performing major industries relative to the BBC2%HYBI were:  Wireline Telecommunications, Health Care, Leisure, Retail and Consumer Products.  From a quality perspective, the credit sensitive CCC-rated sector led the way with a 2.50% total return.  The higher-quality BB-rated sector followed with a 2.01% total return while the B-rated sector returned a respectable 1.75%.

Fund Performance

The following discussion relates to the fund’s A Shares relative to the BBC2%HYBI. The fund underperformed the BBC2%HYBI. The fund was positively impacted by its underweight to the poor-performing Wireline Telecommunications sector.  The fund also benefitted from strong security selection in the Transportation Services sector.  While the fund was negatively impacted by its underweight to the strong-performing Metals sector and its overweight to the weak-performing Health Care sector, strong security selection in these two industry sectors more than offset the sector positioning.  Specific high-yield issuers held by the portfolio that positively impacted performance relative to the BBC2%HYBI included:  Hertz, Ortho-Clinical Diagnostics, Avis Budget Group, Whiting Petroleum and Digicel.

The fund was negatively impacted by its underweight in the strong-performing Oil Field Service sector and by poor security selection in the Independent Energy sector. While the fund benefitted by being underweight the weak-performing Retail sector, this was more than offset by poor security selection within this sector.  The fund’s cash position also negatively impacted performance.  Specific high-yield issuers held by the portfolio that negatively impacted performance relative to the BBC2%HYBI included:  PetSmart, Albertsons Cos., Team Health Holdings, Surgery Center Holdings and Riverbed Technology.  The fund’s total return for the period also reflects 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.

Outlook

Strong corporate credit measures and the synchronized global economic expansion continue to support the high-yield market. New issuance tends to be biased toward higher quality and the primary use of new issuance proceeds continues to be the refinancing of existing debt, both supporting overall market credit quality.  As credit spreads approach 400 basis points, valuations are somewhat stretched but seem poised to move into the 300s given solid global economic growth, strong corporate credit measures and supporting technical conditions.  Geopolitical unrest, central bank policy and unusual dynamics on the political front will need to be monitored closely for signs that they are starting to overwhelm positive investor sentiment, strong corporate credit conditions and the solid economic framework that is supporting high-yield valuations.