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U.S. equity markets advanced during the third quarter of 2013 amid indications of continued economic expansion. The market saw some choppiness during the quarter as investors anticipated that the U.S. Federal Reserve (the "Fed") would begin to withdraw monetary accommodation via reduced bond purchases, though the Fed held off on such a move at its policy meeting on September 18. The U.S. gains came against a generally positive global backdrop: the eurozone economy moved out of recession; Japan's stimulus program spurred renewed optimism that the country will see stronger growth; and China's economy recovered from a June 2013 credit squeeze.
The Fed noted that "national economic activity continued to expand at a modest to moderate pace" between early July and late August, based on reports from the 12 Fed districts. The Fed said manufacturing activity expanded modestly. Consumer spending rose in most Fed districts, reflecting, in part, strong demand for automobiles and housing-related goods.1 The third estimate for the second quarter of 2013 showed that the economy grew by an annualized rate of 2.5%, in line with the previous estimate. First-quarter 2013 growth was 1.1%.2
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 Index3) 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 Index4) 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 Index5) posted a 2.3% return for the quarter. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index6) posted a return of 7.2%, while the floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index7) posted a return of 1.4%.
The Fund returned 7.83%, 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 BofA Merrill Lynch All Convertibles, All Qualities Index,6 returned 7.18% in the same period. Average annual total returns, which reflect performance at the maximum 2.25% sales charge applicable to Class A share investments and include the reinvestment of all distributions, as of September 30, 2013, are: one year: 18.16%; five years: 9.37%; and 10 years: 6.09%. Expense ratio, gross: 1.13%, and net: 1.06%.
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.
The technology and financials sectors were the largest contributors to relative performance during the quarter. Within technology, Salesforce.com, a provider of cloud-based customer relationship management services, has had success expanding into online marketing tools. Micron Technology, Inc. has been strong, as a supply-constrained environment supported prices for its microprocessors. A fire in a competitor's Chinese factory further cut industry production, leading to even higher prices for Micron's memory chips. Equity holding Trulia, Inc., an on-line real estate listing service, rose after reporting better than expected traffic and revenue growth, which should be supported by acquisitions. Within financials, Alliance Data Systems, Inc., a provider of marketing and loyalty programs, benefited from strong growth in its private label business, which runs store-branded credit card programs. The company also raised earnings guidance.
The media and consumer discretionary sectors were the largest detractors from relative performance during the quarter. Within consumer discretionary, we were underweight the automakers, which continued to put up solid results. Notably, the portfolio did not hold Tesla, the maker of high-performance electric cars, which advanced strongly during the quarter. Rental car operator Hertz Global Holdings, Inc. also detracted from relative Fund performance within the sector. Shares fell more than 16% on September 26 after management lowered fiscal 2013 guidance after facing lower rental volume and fleet utilization in the recent quarter. Our positioning within the media sector also hurt relative performance. We were underweight certain broadcasting and media positions that had strong performance during the quarter. Finally, our holding in semiconductor manufacturer Intel detracted from relative performance, as the company suffered from dampened expectations for computer shipments.
Please refer to www.lordabbett.com under the "Portfolio" tab for a complete list of holdings of the Fund, including the securities discussed above.
New convertible issuance continued at a healthy pace during the quarter, although slightly less strong than in the second quarter. Year to date through the end of September, the pace of U.S. convertible issuance is the best it's been since 2008, and has surpassed the level for all of 2012. The convertible new-issue market has benefited from supportive credit spreads and solid equity returns. While we expect issuance to remain firm, the September extension of QEInfinity has tempered our projections somewhat.
The portion of the convertible market that now trades very close to its underlying equity has risen to a level we haven't seen since late 2000. This makes security selection more critical, and has prompted us to trim appreciated holdings in order to manage risk.
On a delta-adjusted basis (delta takes into account the equity sensitivity of the holdings), the portfolio is positioned for a gradually rising interest rate environment. The portfolio continues to be overweight asset-sensitive financial holdings (such as life insurance companies), which should benefit as rates increase, and is underweight utilities and real estate investment trusts (REITs), whose valuations we believe remain inflated due to the unprecedented level of global monetary easing.
In past quarters, the portfolio had a healthy overweight in enterprise technology companies. Recently, however, we cut this overweight as we believe the government shutdown and debt ceiling debates could create an overhang that delays or depresses technology spending, as happened last year. We are focusing instead on technology names that support increased corporate productivity. We also are finding interesting opportunities within biotechnology; our focus is on firms with promising pipelines and near-term catalysts.
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.