Quarterly Update

Charles Luke, Managing Director, Senior Portfolio Manager | Apr. 2021

Opportunistic Credit Bolstered by Rising Interest Rates

Opportunistic credit has low interest rate exposure relative to core fixed income

Global high-yield interest rate sensitivity is at its 10-year average and is stable over history

High-yield credit has a history of performing exceptionally well in the early stages of economic recovery, when growth expectations begin to rise

As global growth appears poised to surge, the brisk upward trajectory of interest rates has reinforced the strong position of opportunistic credit. The 10-year Treasury rate peaked at 1.74% at the end of the first quarter, an increase of 1.20% from the 0.54% low in August 2020. U.S. Treasury debt performed poorly, falling 5.98%, while U.S. investment-grade debt declined 3.7%. Despite the turbulence in core fixed income, global high-yield credit performance has been stellar. U.S. structured credit surged 9.43%, followed by leveraged loans, high-yield and emerging market credit, rising 7.54%, 6.71% and 2.95%, respectively. Why the divergence?

Opportunistic credit has low interest rate exposure relative to core fixed income. The long-term trend of falling borrowing costs has enabled high-quality issuers to refinance debt at lower rates over longer periods, which increases interest rate sensitivity. High-quality bond issues rose 57% to $2 trillion during 2020, the highest amount since 2010, contributing significantly to the 25% overall rise in interest rate sensitivity over a 10-year period.

In contrast, global high-yield interest rate sensitivity is at its 10-year average and is stable over history. Also, global leveraged loans and structured credit, a $2.3 trillion market, utilize floating rate structures that insulate investors from rising rates. Higher rates can actually benefit investors in these asset classes. As borrowing benchmarks move higher, payouts increase and investors receive a higher level of cash flow regardless of purchase price.

Global credit is far more sensitive to the quality of corporate balance sheets and earnings potential, which explains the heavy volatility when solvency is threatened and earnings decline over recessionary periods. However, in the early stages of economic recovery, when growth expectations begin to rise, high yield credit has a history of performing exceptionally well. With yields that are more than four times higher than core fixed income, we continue to believe in the opportunistic credit market as part of every asset allocation framework. The market is poised to produce steady income and add growth as the economy moves from recession to a multiyear expansion.

Key Points

Opportunistic credit has low interest rate exposure relative to core fixed income

Global high-yield interest rate sensitivity is at its 10-year average and is stable over history

High-yield credit has a history of performing exceptionally well in the early stages of economic recovery, when growth expectations begin to rise

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Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

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Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.

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Alternative investments are speculative, entail substantial risks, offer limited or no liquidity, and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying and lengthy lockup provisions. Please see the Offering Memorandum for more complete information regarding the Fund’s investment objectives, risks, fees, and other expenses.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying, and lengthy lockup provisions.

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Index Definitions

The Treasury index is an index based on recent auctions of U.S. Treasury bills and is commonly used as a benchmark when determining interest rates, such as mortgage rates.

The Bloomberg Barclays US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.

The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.

The Palmer Square CLO Debt Index (“CLO Debt Index”) is a rules-based observable pricing and total return index for collateralized loan obligation (“CLO”) debt for sale in the United States, original rated A, BBB, or BB or equivalent.

The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the performance of the largest facilities in the leveraged loan market.

The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market.

The Bloomberg Barclays Global High Yield Index is a multi-currency flagship measure of the global high yield debt market.

Bloomberg Barclays 1-3 Year Government/Credit Index (LGC3truu) is an unmanaged index considered representative of short-term U.S. corporate and government bonds with maturities of 1-3 years.

The Bloomberg Barclays US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.

Bloomberg Barclays U.S. Corporate High Yield Index (barhiyd) is an unmanaged index that is comprised of issues that meet the following criteria: at least $150 million par value outstanding, maximum credit rating of Ba1 (including defaulted issues), and at least 1 year to maturity.

Bloomberg Barclays High Yield Municipal Bond Index (barhiym) is an unmanaged index considered representative of non-investment-grade bonds.

Vanguard Consumer Staples ETF seeks to track the performance of a benchmark index that measures the investment return of consumer staples stocks.

The iShares U.S. Utilities ETF seeks to track the investment results of an index composed of U.S. equities in the utilities sector.

Vanguard Real Estate ETF seeks to track the investment performance of the MSCI US Investable Market Real Estate 25/50 Index.

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