Actively managed, ultra-short duration floating-rate income strategy that invests primarily in privately syndicated, below investment-grade senior secured corporate loans.
- Monetary policy continued to produce market volatility in the second quarter of 2023.
- Class I shares of the Fund outperformed the benchmark the 50% Bloomberg High Yield Bond—2% Issuer Constrained Composite Index/ 50% Morningstar LSTA US Leveraged Loan Index (benchmark) on a net asset value (NAV basis), during the quarter.
- Looking forward, we believe the recent data releases on the economic front have minimized the prospect of a near-term recession.
Monetary policy continued to produce market volatility in the second quarter of 2023. Despite the failure of a fourth U.S. Regional Bank just two days prior, the U.S. Federal Reserve delivered another 25 basis points (bp) hike at their meeting in May. That said, with inflation trending in the right direction, and lending from banks expected to tighten, it was widely believed that this hike might be the last. Inflation data over the next couple of months was relatively well behaved. While the numbers remained elevated, they avoided moving higher. Meanwhile, the labor market remained strong. Monthly job gains surpassed already elevated expectations, with each monthly gain exceeding the previous one. While the Fed did not deliver a hike at their meeting in June, these upside surprises in the labor market eliminated any hope of a “pause”, with market participants instead viewing the Fed’s inaction as a “skip”. Accordingly, a hawkish Fed dot plot signaled that two more rate hikes could be on the horizon for the balance of the year.
Loans and high yield (HY) bonds both experienced a strong quarter, with the Morningstar® LSTA ® US Leveraged Loan Index and Bloomberg U.S. High Yield 2% Issuer Constrained Index up 3.15% and 1.67%, respectively. Loans continue to benefit from a strong carry given high interest rates and have returned 6.48% on a YTD basis (the best return since 2009 for any comparable period). Credit spreads for HY finished the quarter 65 bp tighter at 390 bp. The down-in-quality trade was evident in both markets, as risk appetite remained strong despite some macro uncertainties. BB, B and CCC rated loans returned 2.81%, 3.25% and 4.39%, respectively, while BB, B, and CCC rated bonds delivered respective returns of 0.89%, 1.90% and 4.18%. Nonetheless, performance has not been uniform across all leveraged issuers within the lower-rated stack, as dispersion remains elevated due to idiosyncratic reasons. New-issue activity was relatively light across the leveraged finance space, totaling approximately $103 billion between the two segments, although a slight improvement from last quarter’s $93 billion. Bond issuance saw an uptick, partly due to increased M&A activity and the prevalence of bond-for-loan takeouts (up nearly 30% quarter over quarter), as issuers looked to address upcoming maturities.
Class I shares of the Fund outperformed the benchmark on a NAV basis. The portfolio was modestly skewed to loans over HY bonds in the quarter, while a few collateralized loan obligation (CLO) tranches were purchased during the period as off-benchmark positions. Positive performance drivers in the period included select loans within the software space (RSA Security, Veritas Technologies and Virgin Pulse) that outperformed the broader market due to idiosyncratic reasons, bond holdings in financials sector (Freedom Mortgage and Ladder Capital), and exposure to cruise lines (Norwegian Cruise Lines and Royal Caribbean) that benefited from an uptick in demand for travel. Detractors included holdings in Lumileds, which was downgraded after the company gave a weak earnings outlook and Altice France, as well as the avoidance of Carvana, which rallied from distressed levels. The Fund’s use of leverage boosted returns given the increase in average loan and bond prices experienced during the period.
Current Strategy and Outlook
Looking forward, we believe the recent data releases on the economic front have minimized the prospect of a near-term recession. However, the strength of the labor market and, in turn, the consumer should influence the Fed to maintain a hawkish stance until inflation moderates further. While corporate earnings have remained somewhat resilient, we expect margins to decline during the second half of the year, as pricing power diminishes while the sticky components of core inflation remain elevated. In addition, 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 06/30/23: RSA Security 0.57%, Veritas Technologies 0.48%, Virgin Pulse 0.13%, Freedom Mortgage 0.17%, Ladder Capital 0.26%, Norwegian Cruise Lines 0.30%, Royal Caribbean 0.60%, Lumileds 0.15%, Altice France 0.56%, Carvana 0%; 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to daily change