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The primary focus of fixed-income markets in the third quarter of 2013 remained the future of the U.S. Federal Reserve's (the "Fed") quantitative easing (QE) program. Yields on longer-maturity Treasury issues climbed as investors weighed the likelihood that the Fed would begin to "taper" its $85 billion in monthly purchases of Treasury securities and agency mortgage-backed securities (MBS).
To the surprise of many, the Fed held off on such a move at its policy meeting on September 18. "Taking into account the extent of federal fiscal retrenchment, the committee [Federal Open Market Committee] sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy," the Fed said in a statement following the meeting. However, the central bank "decided to await more evidence that progress will be sustained before adjusting the pace of its purchases."1
Activity in government and municipal debt sectors reflected heightened investor concerns about a sustained rise in interest rates. U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index2) posted a 0.03% return for the three months ended September 30, according to Bloomberg. The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index3) posted a negative return of 0.4%.
Credit-sensitive segments of the fixed-income market fared better in the third quarter. The high-yield bond market (as represented by the BofA Merrill Lynch High Yield Master II Constrained Index4) posted a 2.3% return for the quarter. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index5) posted a return of 7.2%, while the floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index6) posted a return of 1.4%.
Agency MBS (as represented by the Barclays MBS Index7) returned 1.0%. Commercial mortgage-backed securities (CMBS) (as represented by the Barclays U.S. CMBS Index8) returned 1.0%. Investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index9) returned 0.8%.
Inflation measures remained subdued. In August, the overall Consumer Price Index (CPI)10 increased 1.5% over the prior 12 months, below the Fed's target.11 Excluding food and energy, the index rose 1.8% over the prior 12 months.
Meanwhile, labor-market data showed continued sluggish growth in U.S. employment. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 169,000 in August, below the average monthly gain of 184,000 over the prior 12 months, while the unemployment rate dropped to 7.3%, the lowest level since December 2008, reflecting lower labor force participation.12
Corporate credit quality remained consistent with an improving economic environment as the default rate in the high-yield bond market was expected to remain below 2% in 2013 and 2014, according to J.P. Morgan. These estimates are well below the market’s average long-term default rate of 4.0%.
The Fund returned 2.69%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended September 30, 2013. The Fund's benchmark, the Barclays U.S. Aggregate Bond Index,13 returned 0.57% in the same period. A blended index of 60% BofA Merrill Lynch High Yield Master II Constrained Index,4 20% BofA Merrill Lynch All Convertibles, All Qualities Index,5 and 20% Barclays U.S. Aggregate Bond Index returned 2.89%. The blended index is more representative of the diversified nature of the Bond Debenture Fund than is the Barclays U.S. Aggregate Bond Index, which includes only investment-grade securities. Average annual total returns, which reflect performance at the maximum 4.75% sales charge applicable to Class A share investments and include the reinvestment of all distributions, as of September 30, 2013, are: one year: 1.71%; five years: 9.40%; and 10 years: 6.75%. Expense ratio: 0.96%.
Performance data quoted represent past performance, which does not guarantee future results. Current performance may be higher or lower than the performance data quoted. The investment return and principal value of an investment in the fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent month-end, call Lord Abbett at 1-888-522-2388 or visit us at www.lordabbett.com.
Volatility continued in the capital markets throughout the quarter as investors weighed the likelihood that the U.S. Federal Reserve would begin to taper its quantitative easing policy. However, good credit fundamentals, historically low default rates, and investors' reach for yield continued to support the high-yield market.
Within the portfolio's high-yield allocation, top performing names included wireless telecommunications company Cricket Communications, Inc. and media services company Affinion Group, Inc. Detracting from absolute performance were certain high-yield bonds within the metals and mining sector. The portfolio maintains an overweight in high yield versus the benchmark, as we remain positive on the high-yield market from a fundamental perspective.
Convertibles continue to post strong returns year to date. Within the convertibles portion of the portfolio, holdings within the biotechnology and SaaS software sectors contributed to absolute performance. Certain financial and general health care convertible bond holdings also contributed to absolute performance. Within the portfolio's convertible allocation, we continue to focus on companies with good prospects for improving earnings results.
Within the portfolio's investment-grade bond allocation, we maintained little to no exposure to U.S. Treasuries, which added to absolute performance as corporates outperformed Treasuries during the quarter.
Overall across the portfolio, among the industries that contributed the most to absolute performance were technology and electronics, energy, and health care. Among those that either detracted from absolute performance or contributed the least were foreign sovereign, real estate, and banking.
Please refer to www.lordabbett.com under the "Portfolio" tab for a complete list of holdings of the Fund, including the securities discussed above.
Most investors had expected the Fed to announce that it would begin tapering its quantitative easing program following the September meeting of the Federal Open Market Committee. The decision not to commence tapering based on mixed economic data and especially insufficient progress in the creation of new jobs led to an initial rally in bonds sending both yields and spreads lower. Now the market has to contend with when and by how much the Fed will adopt tapering. The consensus currently seems to favor December. Investors also were confronted by the uncertainty of a likely new Fed chairman as well as ongoing macroeconomic issues (e.g., the federal budget, soft global growth) and geopolitical (Syria, Iran) that have the potential to roil the capital markets.
We continue to see good fundamentals, low default rates, and low cost of capital supporting the high-yield asset class. The market also continues to be supported by accommodative monetary policy by central banks. Consequently, we continue to find good, relative value in investment-grade corporates versus Treasuries. We continue to use Treasury futures to hedge some of the duration of the portfolio. The convertibles sector has performed well year to date, and we believe it should continue to provide good value. We are still seeking additional attractive opportunities in that sector.
Performance data quoted is historical. Past performance is not indicative of future results. Current performance may be higher or lower than the performance quoted. The investment return and principal value of an investment in the Fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent quarter-end, go to quarter ending performance on our Website or call Lord Abbett at (888) 522-2388.
1 The Fund’s dividend yield is shown without sales charges (at NAV) and with maximum sales charges (at MOP). The Fund’s dividend yield takes into account any fee waiver or expense limitation arrangements, if any. Without such fee waivers or expense limitation arrangements, the Fund’s dividend yield would have been lower. Information regarding any fee waivers or expense limitation arrangements applicable to the Fund is provided with the Fund’s expense ratio information.
2 The Fund’s unsubsidized dividend yield is shown without sales charges (at NAV) and with maximum sales charges (at MOP). The Fund’s unsubsidized dividend yield reflects what the yield would have been without the effect of fee waivers or expense limitation arrangements.