Actively managed, ultra-short duration floating-rate income strategy that invests primarily in privately syndicated, below investment-grade senior secured corporate loans.
Portfolio Review
Despite intra-quarter volatility, risk assets largely produced positive returns, led by equity markets, while bond markets were flattish in the second quarter. Early in the quarter, volatility was caused by continued strong economic growth in the United States, strong job markets and a mixed decline in inflation data. This led to a bouncing around of both interest rates as well as expectations of potential Fed cuts later in the year. As June approached, economic and payroll data started showing signs of weakness. The May Consumer Price Index (CPI) report surprised to the downside, which caused yields to drop from their recent peak. By the end of the quarter, the yield on the U.S. 10-year Treasury closed 20 basis points (bp) higher overall at 4.40% but off its peaks seen earlier in the period.
Meanwhile, leveraged credit continued to provide steady returns during the period, although performance trailed 1Q24. The Morningstar® LSTA ® US Leveraged Loan Index gained 1.90%, ahead of the 1.09% return for the Bloomberg U.S. High Yield 2% Issuer Constrained Index. The average price of loans declined by 14 bp to 96.59 as secondary trading levels softened in June, while high yield (HY) spreads finished the quarter modestly wider at 309 bp on an option-adjusted spreads (OAS) basis. From a quality perspective, higher-rated credits outperformed during the quarter. BB, B and CCC rated loans returned 1.80%, 2.06% and 1.24%, respectively, while BB, B and CCC rated bonds delivered respective returns of 1.32%, 1.03% and –0.01%. In general, CCC underperformance was more attributable to credit-specific negatives than to a broad aversion to risk. Gross new-issue supply remained active across the leveraged finance space at $221 billion due to ongoing refinancing activity despite still subdued merger and acquisition deal volume. On the demand side, investor flows into leveraged credit were broadly positive during the quarter, driven by attractive all-in yields and still solid economic backdrop.
Class I shares of the Fund outperformed the benchmark on a NAV basis. The Fund benefited from a modest overweight to loans at the asset allocation level, in addition to positive impacts from select individual holdings. The Fund benefited from the sale of an equity holding in Longview Power that was received as part of a prior restructuring, and by avoiding many of the idiosyncratic negatives that weighed on CCC rated issuers returns in the period. Other positives included security selection in Cable and Media, as well as name-specific wins in VistaJet Malta Finance PLC, which continued to recover from weakness in prior periods, as well as Triton Water Holdings, Inc. and Atlantica Sustainable Infrastructure, both of which were acquisition targets.
Current Strategy and Outlook
The macro outlook remains supportive despite the expected slowdown in economic growth, as expectations of Fed cuts later in the year have increased amid cooling inflation and signs of softening in labor markets. Fundamental factors in leveraged credit remain generally healthy, barring a few pockets of stress in the more secularly challenged sectors. We believe the main risks include a more meaningful slowdown in growth and the possibility of margin compression, as pricing power diminishes against the backdrop of disinflation. The prevailing supply and demand imbalance should continue to persist, with net issuance remaining muted, while fund flows and coupon reinvestment support demand. Although spreads don’t appear particularly cheap, solid credit fundamental factors should limit spread widening and the carry from high all-in yields should cushion total returns.
From an asset allocation standpoint, we continue to be overweight loans relative to HY, although we’ve reduced that modestly since last quarter as we near the beginning of an expected Fed easing cycle. In terms of sector positioning, we remain positive on the healthcare space given higher utilization rates and easing labor costs as well as the energy sector, which continues to benefit from firm commodity prices. In addition, we’ve become more constructive recently on the chemicals sector, as we believe the economic weakness in Europe and China has bottomed out. Meanwhile, we continue to hold a cautious stance in industries that 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 6/30/24: Longview Power 0.0%, VistaJet Malta Finance PLC 0.12%, Triton Water Holdings, Inc. 0.32%, Atlantica Sustainable Infrastructure 0.0%. 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to daily change.
Key Takeaways
Despite intra-quarter volatility, risk assets largely produced positive returns, led by equity markets, while bond markets were flattish in the second quarter.
Class I shares of the Fund outperformed 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 (benchmark).
The macro outlook remains supportive despite the expected slowdown in economic growth, as expectations of U.S. Federal Reserve cuts later in the year have increased amid cooling inflation and signs of softening in labor markets.