Fixed-Income Insights
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.
A Note about Risk: The Fund is subject to the general risks associated with investing in debt securities, including market, credit, liquidity, and interest rate risk. The value of an investment in the Fund will change as interest rates fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. Debt securities are subject to credit risk, which is the risk that the issuer will fail to make timely payments of interest and principal to the Fund. The Fund may invest in foreign or emerging market securities, which may be adversely affected by economic, political, or regulatory factors and subject to currency volatility and greater liquidity risk. The Fund may invest in derivatives, which are subject to greater liquidity, leverage, and counterparty risk. Although the Fund may invest in money market securities, this is not a money market fund. These factors can affect Fund performance. Past performance is no guarantee of future results.
The fund’s portfolio is actively managed and subject to change. The fund's benchmark is the ICE BofAML U.S. Treasury Bill Index.
A basis point is one one-hundredth of a percentage point.
The Federal Funds Rate (fed funds rate) is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight.
Quantitative easing, also known as large-scale asset purchases, is a monetary policy whereby a central bank buys predetermined amounts of government bonds or other financial assets in order to add money directly into the economy.
Spread duration is an estimate of how much the price of a specific bond will move when the spread of that specific bond changes
The ICE BofAML U.S. Treasury Bill Index tracks the performance of US dollar denominated US Treasury Bills publicly issued in the US domestic market. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and an investor cannot invest directly in an index.
Source ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN "AS IS“ BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD ABBETT, OR ANY OF ITS PRODUCTS OR SERVICES.
The views and information discussed in this commentary are as of the publication date, are subject to change, and may not reflect the views of the firm as a whole. The views expressed in market commentaries are at a specific point in time, are opinions only, and should not be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Information discussed should not be considered a recommendation to purchase or sell securities.
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Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.