Voya Strategic Income Opportunities Fund Quarterly Commentary - 3Q22

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Unconstrained Fixed Income

Unconstrained and flexible approach, investing broadly across the global debt markets.

Key Takeaways

  • For the quarter, the Strategy underperformed its benchmark, the ICE Bank of America U.S. Dollar Three-Month Deposit Offered Rate Constant Maturity index (the “index”).
  • The 2Q22 was largely a continuation of 1Q21. Growth was slower than expected, inflation persisted, and Treasury yields continued to climb.
  • Spreads moved wider and lower-quality sectors trailed higher-quality sectors.
  • Rates and credit spread volatility led to detractions from sector allocation and duration and yield curve decisions. security selection was mixed and in total was a more modest detraction

Portfolio Review

For the quarter ended September 30, 2022, the Strategy underperformed the Index. Duration weighed on performance as rates continued to rise, while sector allocation and security selection contributed.

The unusual environment of slower growth, high inflation and a tight labor market continued to drive market volatility in the third quarter of 2022. Recent tightening by the Fed has had a clear impact on interest rate sensitive parts of the economy such as housing but has not had the desired effect of cooling the labor market and wages. The additional 75 basis points (bp) rate hike delivered by the Fed at their July meeting was fully expected by markets, however Powell’s comments after the meeting, which were perceived to be on the dovish side, sent yields lower. Speculation of a Fed “pivot” began to grow, and as a result, financial conditions began to ease, fueling a rally in risk assets. This dynamic came to a swift and decisive end following Powell’s speech at Jackson Hole in which he declared the economy would feel “some pain” as the Fed will need hold a restrictive stance for an extended period of time. Further fueling the resumed selloff was a hotter than expected Consumer Price Index (CPI) reading, which reset the clock for a potential pause in rate hikes, as well as a surprise uptick in the number of job openings. By September, another 75 bp rate hike was fully expected by markets, and the Fed delivered on those expectations while also reiterating their intentions of “higher for longer”. After dropping close to 2.50% intra-quarter, the 10-year Treasury closed the quarter around 80 bp higher at 3.83%. The selloff in the 2-year was even more dramatic, leading to a further inversion of the yield curve.

Positive correlation between rates and spreads continued through 3Q22, however spreads finished the quarter roughly where they started. The see-saw in interest rates contributed to spread sectors performing in a similar up and down fashion. High yield (HY) corporate bonds proved to be an exception to rule as the sector posted positive nominal and excess returns for the quarter. Meanwhile, the agency mortgage-backed securities (MBS) market was rattled by ongoing rate volatility resulting in that sector posting the worst relative performance for the quarter.

Rate risk remained a hurdle, while a more defensive posture with a bias towards liquidity and tactical sector shifts added to supported outperformance. The continued march higher in interest rates weighed on nearly all sectors of the bond market, setting the tone for a negative return for the period. As a result, duration and yield curve positioning was the largest detractor for the period. Within sector allocations, the strategy benefited the most from our HY corporate exposures, as this sector bucked the trend and posted positive performance for the period. Emerging markets (EMs) also added. Meanwhile, securitized allocations delivered mixed results. Our tactical positioning in agency residential mortgage-backed securities (RMBS) was a small contributor. However, more credit sensitive sectors including non-agency RMBS and credit risk transfers (CRTs), commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) all detracted as spreads moved wider. During the period, we reduced allocations to agency RMBS after solid performance in July and concerns over rate volatility impacting that sector. We deployed capital into investment grade (IG) corporate bond markets, with a focus on short-term maturities as nominal yields and the widening in spreads offered attractive opportunities. Lastly, we trimmed EM allocations as the economic outlook has become less certain. Security selection was also positive across sovereign and corporate hard currency markets. Security selection, in aggregate, was positive albeit with mixed results. Positive security selection came from HY and EM, while agency RMBS and CMBS modestly detracted.

Current Strategy and Outlook

Higher prices have taken a significant bite out of household income, and as a result, consumer spending on an inflation adjusted basis has stagnated. We expect this trend to continue, with further monetary tightening resulting in additional demand destruction that will lead to an environment of weak global growth and US growth below trend if not negative. We do not however, expect a deep recession. This is because, while inflation has created a challenge for spending growth, the strong financial position of households, having recently de-levered in the early days of the pandemic, grants consumers the ability to maintain spending levels, with job security created by the excess demand for labor supporting their willingness to spend.

With a background of weaker global growth, we expect inflation to slowly decline in the months ahead, while the shelter component will keep inflation above the Fed’s comfort zone well into 2023. As a result, the Fed will push further into restrictive territory until inflation is clearly moving toward their target and will resist the urge to ease as long as the labor market remains strong.

With a difficult, and narrow path to a soft landing, the portfolio remains in a relatively defensive posture. With liquidity challenged, we have used liquid instruments to both hedge risk and take advantage of tactical market opportunities presented by the elevated level of volatility.

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The Bank of America Merrill Lynch U.S. Dollar Three- Month LIBOR Constant Maturity Index is designed to track the performance of a synthetic asset paying LIBOR to a stated maturity. The index is based on the assumed purchase at par of a synthetic instrument having exactly its stated maturity and with a coupon equal to that day’s fixing rate. That issue is assumed to be sold the following business day (priced at a yield equal to the current day rate) and rolled into a new instrument. The Index does not reflect fees, brokerage commissions, taxes or other expenses of investing. Investors cannot directly invest in an index. BofA Merrill Lynch® indices used with permission, are provided “AS IS”, without warranties, and with no liability. BofAML does not sponsor, endorse, review, or recommend Voya or its products or services.

Principal Risks: All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield. High-Yield Securities, or “junk bonds,” are rated lower than investment-grade bonds because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities. To the extent that the Fund invests in Mortgage-Related Securities, its exposure to prepayment and extension risks may be greater than investments in other fixed-income securities. The Fund may use Derivatives, such as options and futures, which can be illiquid, may disproportionately increase losses and have a potentially large impact on Fund performance. Foreign Investing poses special risks including currency fluctuation, economic and political risks not found in investments that are solely domestic. As Interest Rates rise, bond prices fall, reducing the value of the Fund’s share price. Other risks of the Fund include but are not limited to: Credit Risks, Extension Risks, Investment Models Risks, Municipal Securities Risks, Other Investment Companies’ Risks, Prepayment Risks, Price Volatility Risks, U.S. Government Securities and Obligations Risks, Debt Risks, Liquidity Risks, Portfolio Turnover Risks, and Securities Lending Risks. An investment in the Fund is not a bank deposit and is not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency.

The strategy employs a quantitative investment process. The process is based on a collection of proprietary computer programs, or models, that calculate expected return rankings based on variables such as earnings growth prospects, valuation, and relative strength. Portfolio construction uses a traditional optimizer that maximizes expected return of the portfolio, while managing tracking error.

Data imprecision, software or other technology malfunctions, programming inaccuracies and similar circumstances may impair the performance of these systems, which may negatively affect Fund performance. Furthermore, there can be no assurance that the quantitative models used in managing the Fund will perform as anticipated or enable the Fund to achieve its objective.

This commentary has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities. Past performance is no guarantee of future results.

The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Portfolio holdings are fluid and are subject to daily change based on market conditions and other factors. The Fund discussed may be available to you as part of your employer sponsored retirement plan. There may be additional plan level fees resulting in personal performance to vary from stated performance. Please call your benefits office for more information.

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