Actively managed, ultra-short duration floating-rate income strategy that invests primarily in privately syndicated, below investment-grade senior secured corporate loans.
- Despite the weaker tone in broader markets, the economic backdrop benefited higher beta sectors in fixed income.
- 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) during the quarter.
- While the likelihood of a soft landing has increased in recent months, there remains no shortage of economic, political and geopolitical issues that could derail such a benign outcome
The third quarter of 2023 contained an abundance of strong data, as the prospect of a soft landing gained credibility. Inflation continued to trend in the right direction, as Core Personal Consumption Expenditures Price Index, which at its peak was running at a year over year rate of 5.6%, fell to 3.8% by the end of August. Meanwhile, the economy continued to add jobs at a fast pace. The combination of falling inflation and a strong labor market allowed consumers to continue spending, creating a tailwind for gross domestic product growth. Maintaining a data dependent stance, the Fed responded to this better-than-expected data by hiking rates at their July meeting. In September, the U.S. Federal Reserve kept rates unchanged, however their updated dot plot projection reinforced a “higher for longer” message. This led to a broad sell-off across rates, leading to disappointing returns across both fixed income and equities.
Despite the weaker tone in broader markets, the economic backdrop benefited higher beta sectors in fixed income. Spreads held well in both loans and high yield (HY) bonds, with the difference in total returns driven by the underlying rate move weighing on bond returns. The Morningstar® LSTA ® US Leveraged Loan Index returned 3.46%, while the Bloomberg U.S. High Yield 2% Issuer Constrained Index gained 0.46%. Loans continue to benefit from a strong carry and limited exposure to rate volatility, with the year-to-date return of 10.16% representing the best return since the Global Financial Crisis. In the HY market, credit spreads tightened in July before widening in September to roughly the same level to start the quarter at 394 basis points (bp) on an option-adjusted spread (OAS) basis. The down-in-quality trade was evident in both markets, as risk appetite remained strong despite continued macro uncertainties. BB, B and CCC rated loans returned 2.21%, 3.85% and 6.05%, respectively, while BB-, B-, and CCC-rated bonds delivered respective returns of –0.40%, 0.84%, and 2.51%. New-issue activity increased across the leveraged finance space ($118 billion versus $103 billion last quarter), primarily due to an uptick in loan issuance. Total volume in the quarter for the loan segment was $76.3 billion, while HY was subdued at $41.1 billion. While the use of proceeds largely remained opportunistic in nature, leveraged buyout and M&A supply saw a notable uptick in the loan market at $27.8 billion (five-quarter high).
Class I shares of the Fund underperformed the benchmark on a NAV basis. While an overweight allocation to loans benefited the Fund, performance was negatively impacted by a few idiosyncratic challenges during the quarter. Negative performance drivers in the period included exposure to Save-A-Lot (weak earnings), holdings in the cable space (primarily due to Charter Communications Operating, LLC ) and exposure to Commscope, Inc. within the technology sector, as the company posted weak quarterly earnings. Meanwhile, contributors included select software related names (Imperva, Inc., Veritas Technologies Corp. and Ivanti Software, Inc.) that outperformed the broader market due to idiosyncratic reasons and exposure within independent energy and chemicals that benefited from stronger commodity prices.
Current Strategy and Outlook
The macro environment remains uncertain. The likelihood of a soft landing has increased in recent months, but there remains no shortage of economic, political and geopolitical issues that could derail such a benign outcome. On the positive side, a strong job market, rising wages, declining inflation and generally solid consumer and corporate balance sheets support further economic momentum. Negatives of note include higher interest rates, higher oil and gasoline prices, a sluggish recovery in China and political dysfunction in Washington. In general, we are closely monitoring consumer health and margin compression at the corporate level, while a more active new-issue calendar has allowed us to look for opportunities in the primary market. We expect dispersion in performance among borrowers to continue and pockets of stress to emerge as the cycle matures. As such, our focus will be on security selection and finding pockets of value in an increasingly dispersed market.
Companies mentioned in this report – percentage of Fund investments, as of 09/30/23: Save-A-Lot 0.49%, Charter Communications Operating, LLC 0.76%, Commscope, Inc. 0.28%, Imperva, Inc. 0.33%, Veritas Technologies Corp. 0.50%, Ivanti Software, Inc. 0.72%; 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to daily change.