Quarterly Update

Gregory S. Kaplan, Director of Fixed Income, Managing Director | Jan. 2021

Economic Optimism Is Headwind for Rates, Tailwind for Credit Risk

Expect market interest rates and inflation to remain low but with upward bias

Inflation to firm, but remain contained; credit sectors likely to outperform

Expect low- to mid-single-digit returns for fixed income in 2021

Despite near-term challenges with higher COVID-19 virus rates and vaccine distribution, the generally optimistic outlook in response to vaccine progress supports our positive outlook for the U.S. economy. This will likely pressure market rates and push inflation modestly higher but not enough to pull the Federal Reserve off the sidelines. The adoption of “flexible average inflation targeting” by the Fed in 2020, along with continued low inflation, strongly suggests accommodative Fed policy will remain little changed in 2021. We also anticipate no change to the current $120 billion in bond purchases each month that will serve to expand the Fed’s balance sheet and effectively inject additional liquidity into the U.S. economy. We expect the overnight Fed Funds rate to remain unchanged at 0.0%-0.25% and the 10-year U.S. Treasury yield to end the year in the range of 0.80%-1.3%.

Increasing inflation expectations will likely test our low-inflation thesis into the second quarter as both accommodative monetary and fiscal stimulus are met with improving sentiment. Our forecast for low inflation remains grounded in the negative output gap (economy running below potential) and labor market gap (unemployment remaining above “full employment”) that are likely to persist well into 2022, if not longer.

Corporate leverage remains a concern, but investors should note that much of last year’s heavy debt issuance was meant to create cash stockpiles to backstop uncertainty and is a credit positive for many issuers. Similarly, dire predictions for municipal budgets have proven too pessimistic, and while we expect additional credit downgrades, fears of defaults remain overblown. We favor lower tiers of the investment grade spectrum in 2021.

After a year that saw the Bloomberg Barclays U.S. Aggregate index return 7.5%, we anticipate 2021 to be more modest, with investment grade returns around 1-2% and high-yield returns in the 5-7% range. Any short-term spike in interest rates should be viewed as an opportunity to add exposure and/or extend duration, while market volatility will likely present opportunities to add credit risk. We continue to favor opportunistic sectors over core fixed income for our client portfolios as appropriate.

Key Points

Expect market interest rates and inflation to remain low but with upward bias

Inflation to firm, but remain contained; credit sectors likely to outperform

Expect low- to mid-single-digit returns for fixed income in 2021

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Important Disclosures

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

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.

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.

Concentrating assets in a particular industry, sector of the economy, or markets may increase volatility because the investment will be more susceptible to the impact of market, economic, regulatory, and other factors affecting that industry or sector compared with a more broadly diversified asset allocation. Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.

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.

CNR is free from any political affiliation and does not support any political party or group over another.

Index Definitions

Bloomberg Barclays Municipal Bond Index is a market-value-weighted index for the long-term tax-exempt bond market. To be included in the index, bonds must have a minimum credit rating of Baa. They must have an outstanding par value of at least $7 million and be issued as part of a transaction of at least $75 million. The bonds must be fixed rate, have a dated-date after December 31, 1990, and must be at least 1 year from their maturity date.

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

Indices are unmanaged and one cannot invest directly in an index.

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