The Lord Abbett Ultra Short Bond Fund: An Update

How have we positioned the Fund during the current market volatility?

Uncertainty about the economic impact from the worldwide spread of COVID-19 has whipsawed financial markets in March 2020. The month saw an additional catalyst for volatility develop with the breakdown in the OPEC (Organization of Petroleum Exporting Countries) alliance and a petroleum price war between Saudi Arabia and Russia.

In response to the uncertainty, the U.S. Federal Reserve (“Fed”) cut the federal funds rate by half a percentage point on March 3. With markets continuing to gyrate as the disease increased its global footprint, the Fed made additional emergency moves on March 15, including cutting rates by 100 basis points (bps) to near zero and launching a $700 billion quantitative easing program.

The virus concerns led investors to sell equities and embrace haven assets, especially U.S. Treasuries, with yields declining sharply into mid- March. High grade corporate bonds, as measured by the ICE BofAML U.S. Corporate Bond Index, were negatively impacted by the significant spread widening of 121 bps over the year-to-date period, returning -0.92% through March 12.

Portfolio Review
In response to the market volatility, the Lord Abbett Ultra Short Bond portfolio experienced a recent drop in value, primarily attributable to the wider spread levels on short-term, high-quality fixed income, specifically investment grade corporate floating rate notes (FRNs).

Indeed, FRNs experienced volatility amid corporate credit spreads widening and technical pressures, resulting in negative returns through March 16. Given a nearly 43% allocation to FRNs as of March 16, the portfolio was negatively affected. We do maintain the view that the volatility is not a result of a credit or default issue, and these short-term issues will mature at par.

U.S. Treasury bills experienced relatively strong returns over the year-to-date through March 16, as Treasury rates significantly rallied. Since the Ultra Short Bond Fund’s benchmark is comprised solely of T-bills, the portfolio’s underweight allocation dragged on relative performance.

The portfolio’s allocation to asset-backed securities (ABS) has supported relative performance. Despite the fact that ABS have also been negatively affected by spread widening, they have held up better relative to FRNs. We have also used ABS to focus on higher quality exposures (primarily AAA-rated issues), which have better weathered the market turmoil. We favor ABS that are backed by credit cards and auto loans, and have avoided areas of the market that have been more directly exposed to the impact of the coronavirus (such as containers, aircraft and timeshares).

Portfolio Positioning
Coming into this recent period of volatility we had been maintaining a defensive posture within the Ultra Short portfolio, focusing on higher-quality opportunities. While the Ultra Short Bond strategy can hold up to 15% in ‘BBB’-rated securities, the portfolio’s BBB allocation was approximately 9% as of February 28, 2020, at the lower end of the historical range. Additionally, the portfolio’s overall risk levels, in terms of spread duration, were at the lower end of where we have been historically.

The portfolio held roughly 5% within the energy sector (as of February 28). However, this was predominantly short-term commercial paper, maturing in less than two months. We believe that the companies that the portfolio holds within the energy sector have availability on their revolving credit facilities to meet upcoming commercial paper maturities. We currently do not intend to roll over energy-related commercial paper or add to the portfolio’s energy exposures.

We are closely monitoring activity within the commercial paper market. The current supply and demand imbalances have led to unusually wide spreads in high-quality, short-term commercial paper.

In addition to holding a fair amount of cash, the portfolio has a high degree of natural liquidity from commercial paper maturing on a daily basis. We are modestly increasing the portfolio’s allocation to floating rate notes, as we are finding attractive opportunities given the dislocation, and taking advantage of notes that are trading at a discount to par.

While there has been a great deal of volatility in rates and spreads, the portfolio remains high-quality, short-term and very liquid. This high degree of liquidity should allow us to take advantage of attractive opportunities as spreads widen within the investment grade floating rate note and commercial paper markets.

Outlook
We are closely monitoring the impact of the market volatility within the portfolio. However, the portfolio has been relatively stable compared to the market movements in other asset classes amid the significant moves we have seen in interest rates and credit spreads.

Overall, in response to the volatility, we are not making drastic moves that would radically change the portfolio, as there is a lot of uncertainty in the market. Rather, we are monitoring market volatility, and making tactical adjustments based on where we are finding attractive relative-value opportunities.

We continue to emphasize liquidity and flexibility within the portfolio and are tactically adjusting exposure to favor asset classes that offer attractive risk-adjusted carry opportunities.