Actively managed, ultra-short duration floating-rate income strategy that invests primarily in privately syndicated, below investment-grade senior secured corporate loans.
Key Takeaways
- Risk assets enjoyed a strong first quarter as U.S. economic growth beat expectations.
- Class I shares of the Fund underperformed the benchmark on a net asset value (NAV basis), the 50% Bloomberg High Yield Bond—2% Issuer Constrained Composite Index/ 50% Morningstar LSTA US Leveraged Loan Index (the benchmark).
- The macro outlook remains supportive, as solid economic growth should continue to underpin corporate fundamental factors.
Portfolio Review
Risk assets enjoyed a strong first quarter as U.S. economic growth beat expectations. The S&P 500 Index reached a new high and advanced by 10.56% on a total return basis during the quarter and the Nasdaq Composite had a price return of 9.11%. Credit spreads across corporate, securitized and emerging markets sectors finished broadly tighter. The Federal Open Market Committee voted to hold interest rates steady for the fifth consecutive time at its March meeting. However, markets converged with the U.S. Federal Reserve’s guidance on the timing of the first rate cut as the disinflation dynamic that characterized 2023 lost momentum, suggesting a growing consensus on the future direction of monetary policy and a rejection of a more significant pivot that was priced at the start of the year.
This backdrop was positive for higher beta sectors within fixed income, including leveraged credit and collateralized loan obligations (CLO). Spreads moved tighter across both senior loans and high yield (HY) bonds, with loans outperforming during the quarter given their floating rate component, as Treasury yields moved higher on the back of the hotter-than- expected inflation data. The Morningstar® LSTA ® US Leveraged Loan Index gained 2.46%, while the Bloomberg U.S. High Yield 2% Issuer Constrained Index returned 1.47%. Spreads remained supported by strong demand given attractive yields despite an uptick in new-issue supply from the prior quarter. From a ratings perspective, lower-rated credits outpaced higher quality. BB, B and CCC rated loans returned 2.00%, 2.45% and 5.17%, respectively, while BB, B and CCC rated bonds delivered respective returns of 1.13%, 1.36% and 2.14%. Gross new- issue activity increased significantly across the leveraged finance space ($228 billion versus $118 billion last quarter), driven by a large uptick in refinancing activity and a small increase in merger and acquisition (M&A) origination.
Class I shares of the Fund underperformed the benchmark on a NAV basis. While the Fund was helped by a modest overweight to loans at the asset allocation level, a few idiosyncratic headwinds detracted from performance. The primary detractors were Save-A-Lot (weak earnings), select holdings in the retail space, exposure within media (primarily due to Altice France S.A.), and the Fund’s equity holdings in Longview Power, which was received as part of a prior restructuring. In contrast, the main contribution was the equity position in Yak Mat (received as part of a prior restructuring), as the company agreed to be acquired during the period. Additional benefits included exposure within cable and satellite (primarily due to an underweight to lower quality issuers in the space), and selection within metals and mining, largely as a result of holding First Quantum Minerals Ltd.
Current Strategy and Outlook
The macro outlook remains supportive, as solid economic growth should continue to underpin corporate fundamental factors. While the Fed’s hiking cycle is done, the first rate cut remains a source of debate. With inflation surprising to the upside recently, along with continued strength in economic data, the Fed’s case to remain patient on rate cuts has been bolstered. However, their data-dependent stance will provide flexibility in adjusting policy measures in response to evolving economic conditions, ensuring a balanced approach to supporting economic growth while addressing inflation concerns. Market technical factors in leveraged credit remain favorable as net issuance has been low given lack of meaningful M&A activity, while demand has been supported by attractive all-in yields. However, spreads remain at tight levels, skewing outcomes negatively in the event of any surprises.
From an asset allocation standpoint, we remain overweight loans relative to HY given higher-for-longer rate environment. In sector positioning, we remain positive on the healthcare space given higher utilization rates and easing labor cost, and the energy sector which continues to benefit from firm commodity prices. However, we are less constructive on global cyclicals as a whole given still muted recovery from China and Europe. Furthermore, we maintain a cautious stance in industries that continue to face secular challenges, such as media and cable. From a ratings perspective, we maintain a single-B average credit profile, with a continued focus on single-name risk
Holdings Detail
Companies mentioned in this report – percentage of Fund investments, as of 3/31/24: Save-A-Lot 0.27%, Altice France S.A. 0.19%, Longview Power 0.03%, Yak Mat 0.30% and First Qauntum Minerals Ltd. 0.27%; 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to daily change.
Key Takeaways
Risk assets enjoyed a strong first quarter as U.S. economic growth beat expectations.
Class I shares of the Fund underperformed the benchmark on a net asset value (NAV basis), the 50% Bloomberg High Yield Bond—2% Issuer Constrained Composite Index/ 50% Morningstar LSTA US Leveraged Loan Index (the benchmark).
The macro outlook remains supportive, as solid economic growth should continue to underpin corporate fundamental factors.