Quarterly Update

Charles Luke, Managing Director, Senior Portfolio Manager | Jul. 2020

Prices Recover Sharply in Opportunistic Credit

Fed support, new issue demand drive returns

Defaults remain relatively low in most sectors

High returns accompany rising default expectations

The price drop in opportunistic credit, sharp and widespread during the first quarter, was followed by a 12.2% rise in the second quarter.1 Federal Reserve support and heavy demand for new issuance debt, even for risky issuers in travel and energy sectors, are driving returns. Expectations for Congressional support are also helping to boost confidence.

The recovery in prices came in waves, originating in core, U.S. based assets and later spreading to structured and emerging market bonds. Quality tiers experienced a similar trend. In the U.S., BB bonds climbed first and the most, to 11.5%, followed by B and CCC bonds later in the quarter, rising 8.6% and 9.1%, respectively.2

Despite the recovery, defaults are rising. During the first five months of the year, 41 companies defaulted, totaling $70.8 billion in bonds and leveraged loans. The U.S. high yield default rate has risen over 5.0% from a low of 2.5% at the beginning of 2020. Despite the aggregate rise in defaults, most sectors are not faltering. Energy, Cable and Satellite, Retail and Telecommunications make up 75.4% of the total defaults, with a failure rate of 13.8%. All other sectors have a combined default rate of 3.2%.3

Company failures generate negative headlines, but as default expectations rise, high returns follow. Historically, well above average returns occur before defaults peak. Given the dispersion of stress, we continue to recommend positions within U.S. opportunistic credit, although yields are lower today than they were at the end of the first quarter. We believe return profiles remain elevated and the high level of demand for income, as well as the lack of alternatives, will continue to support durable positions in well-managed companies.

Footnotes:

1Bloomberg Barclays High Yield Global Credit, LG30TRUU, 2Q return

2Bloomberg Barclays US High Yield BB, BCBATRUU; Bloomberg Barclays US High Yield B, BCBHTRUU; Bloomberg Barclays US High Yield CCC, BCAUTRUU

3All default data from JP Morgan

Fed support, new issue demand drive returns

Defaults remain relatively low in most sectors

High returns accompany rising default expectations

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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.

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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.

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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.

Index Definitions

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

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

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.

Bloomberg Barclays Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility and financial issuers.

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

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