Widening the Opportunity Set in Credit | Lord Abbett
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Fixed-Income Insights

We believe there are significant opportunities to capture liquidity premiums across credit sectors today.

Read time: 6 minutes

In Brief

  • The potential for episodic credit market volatility is increased by structural changes to the amount of risk that can be absorbed by credit market dealers and heightened event risk in global markets.
  • The Credit Opportunities Fund's investment strategy focuses on an expanded group of fixed-income asset classes, seeking to capitalize on dislocations in liquidity premiums to find potential opportunity and navigate through volatility.
  • We believe the interval fund structure provides the appropriate vehicle to capture liquidity premiums in opportunities that have traditionally been reserved for institutions.
  • The Fund may be a potential solution for those investors who examine and understand their liquidity needs, investment horizons, and tolerance for investment risks.

Volatility Among Credit Sectors Has the Potential to Continue

2020 was an exceptionally volatile year for the credit markets. Record redemptions of taxable-bond funds in March 2020 fueled a selloff that was met with fewer dealers buying risk due to regulatory changes stemming from the global financial crisis (GFC) of 2008. We believe these regulatory adjustments have had a positive effect on the overall health of the U.S. financial system, but the net effect during the unforeseeable COVID-19 crisis was a liquidity imbalance in March 2020 that contributed to exaggerated price moves during the downturn. Liquidity premiums, which are the cost of daily liquidity in the form of lower compensation, or yield, for similar credit risks, rose significantly as asset values fell precipitously. While many asset classes provided liquidity during the pandemic-induced selloff, this liquidity was accompanied by prices far below market values of just one month earlier.

Although the dust has settled from the tumult of the pandemic in early 2020, we believe there are several reasons why ongoing periods of volatility will persist. First, structural changes to the amount of risk that banks and sell-side financial firms can carry on their balance sheets have reduced their ability to act as an intermediary buffer, or dealer, during times of market dislocation. Second, geopolitical events have more influence today on the global economy, increasing the potential for more regular disruptions to global investment markets. Although credit markets have been relatively healthy since the GFC, there have been multiple episodes of stress in specific sectors over this period, as shown in Figure 1.

 

Figure 1. Episodes of Post-GFC Crisis Market Volatility Provide Potential Opportunities Within Market Sectors Under Stress

Source: Lord Abbett. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

The Lord Abbett Credit Opportunities Fund’s strategy seeks to take advantage of market or sector dislocations and liquidity mismatches, with an eye to capturing liquidity premiums. Asset class and sector weights are actively managed, while individual positions are built upon deep, fundamental credit investment research. We believe the strategy will have ample prospects for dislocated credit opportunities that provide the potential to earn outsized returns throughout the cycle, given the structural shifts just mentioned.

Focusing in on 2020

A closer look at the credit market dislocation during 2020 reveals that the impact was not spread evenly among fixed-income asset classes. And the recovery, while impressive, resulted in disparate results for the full-year period (see Figure 2). The varying degrees of decline and recovery, or volatility, may have been potentially dampened by diversification among credit asset classes and sectors. And a manager’s ability to rotate among both may help to navigate through periods of market stress, trimming positions that have held up well in relative terms to take advantage of dislocated values during volatile periods, similar to the episodes shown in Figure 1.

 

Figure 2. A Sharp Selloff Was Followed by A Strong Recovery in 2020

Fixed-income index returns during periods in 2020

Sources: Bloomberg Index Services Limited, ICE Data Indices, LLC, and Credit Suisse. 1Bloomberg Barclays U.S. Treasury Index. 2Bloomberg Barclays U.S. Aggregate Bond Index. 3Bloomberg Barclays U.S. Investment Grade Corporate Bond Index. 4Bloomberg Barclays U.S. Investment Grade BBB-Rated Corporate Bond Index. 5ICE BofA U.S. High Yield Bond Index. 6ICE BofA U.S. High Yield Bond BB-Rated Index. 7ICE BofA U.S. High Yield Bond B-Rated Index. 8ICE BofA U.S. High Yield Bond CCC-Rated Index. 9Credit Suisse Leveraged Loan Index.

 

Navigating Through the Volatility and Finding Opportunity

As with credit markets generally, the Credit Opportunities Fund experienced a decline in net asset value (NAV) in the first quarter of 2020 due to disorderly pricing mechanisms created by the unprecedented selloff. Subsequent returns following the decline, as well as those posted in 2021, are shown in Figure 3. On a relative basis, returns following the first quarter of 2020 have been strong compared to the broad high yield bond market, and full year 2020 results were ahead of the individual asset class returns detailed in Figure 2.

Importantly, the Fund is not managed to a specific benchmark. Portfolio holdings are selected based purely on the convictions of the investment team and are not influenced by position, sector, or asset class weights in an index. But return comparisons are shown against the broad high yield bond market to provide additional context.

 

Figure 3. Performance During and After the March 2020 Disruption

Lord Abbett Credit Opportunities Fund returns

Gross expense ratio: 2.32%

Net expense ratio: 2.25%

*Fund Incepted on February 15, 2019

Sources: ICE Data Indices LLC and Lord Abbett. Class A - The inception date for Class A shares is September 13, 2019. The performance quotations for Class A are based on the historical performance of the Fund’s Class I Shares, since inception (02/15/2019), restated to reflect all charges and fees applicable to Class A shares. For periods after September 13, 2019, actual Class A performance is used, which reflects all charges and fees applicable to Class A shares.

Performance data quoted reflect past performance and are no guarantee 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. You can obtain performance data current to the most recent month end by calling Lord Abbett at (888) 522-2388 or referring to our website at lordabbett.com. The net expense ratio takes into account contractual fee waivers/expense reimbursements that currently are scheduled to remain in place through 04/30/2022. For periods when fees and expenses were waived and/or reimbursed, the Fund benefited by not bearing such expenses. Without such fee waivers/reimbursements, performance would have been lower. Instances of high double-digit returns were achieved primarily during favorable market conditions and may not be sustainable over time. Returns are based on total return at net asset value, including the reinvestment of dividends and capital gains, if any. Class A Shares purchased subject to a front-end sales charge have no contingent deferred sales charge (CDSC). However, certain purchases of Class A shares made without a front-end sales charge may be subject to a CDSC of 1.50% if the shares are repurchased before the first day of the month in which the one-year anniversary of the purchase falls. The CDSC is not reflected in the performance with maximum sales charge.

 

A severely dislocated credit market in March 2020 provided an opportunity for the Fund to invest in select higher-quality, investment-grade issues at discounted valuations, generating highly attractive total returns accompanied by strong yields. As 2020 progressed, opportunities were found in investments with undervalued leverage to a return to normal economic activity post-COVID-19, as well as fundamental and structural characteristics that limited downside. The reopening theme was central to the Fund, as sentiment around global macroeconomic strength benefited from the development and rollout of vaccines, as well as the introduction of multiple stimulus packages.

Overall, returns following the period of market disruption reflect a continuation of the investment approach, seeking to capitalize on market or sector dislocations and idiosyncratic risk across a broader set of credit asset classes to source potential income and total returns.

Broadening the Spectrum of Opportunity

The Credit Opportunities Fund’s investment universe spans twelve distinct credit sectors, including those that are less liquid than traditional fixed-income segments (see Figure 4). The widened scope of the strategy provides the investment team with multiple asset classes from which they can source potential investment ideas and take advantage of sporadic episodes of volatility. Diversification may also mitigate a fair portion of the risk of periods of reduced market liquidity and enhance maneuverability through dislocations in select credit sectors, although diversification cannot guarantee a profit or protect against losses in a declining market. We believe there are significant opportunities to capture liquidity premiums in the less-liquid segments of the credit markets, and investors’ search for yield in the current low-rate environment should continue to be supportive of capital inflows into those asset classes.

 

Figure 4. The Lord Abbett Credit Opportunities Fund Invests Across Multiple Fixed-Income Sectors

Twelve credit sectors provide an expanded investment opportunity set.

Source: Lord Abbett. CLO is a collateralized loan obligation. ABS is an asset-backed security. MBS is a mortgage-backed security. Please see sector definitions in the disclosure
.

 

An Interval Fund Structure Provides the Appropriate Vehicle to Capture Liquidity Premiums

The Credit Opportunities Fund is structured as an unlisted, closed-end interval fund. The Fund is not liquid, like a daily liquidity mutual fund. An interval fund is required to offer to repurchase a certain percentage of shares at set periods, or intervals, at a price equal to the fund’s NAV. These periods are typically set each quarter, and shareholders are provided with a repurchase schedule of the quarterly dates.

The interval fund structure allows the Fund to invest across a wider range of credit sectors, including less-liquid credit segments that may offer the potential to generate higher long-term returns. For individual investors, the Fund also provides a vehicle to access strategies that are generally reserved for institutions, such as hedge funds or pension plans. Interval funds are designed for long-term investors and may also minimize the detrimental impact that large fund flows can have on investor returns.

Since the Fund has scheduled periods that provide investors with predetermined dates on which they can sell a certain amount of shares back to the Fund, the strategy can take a longer-term view of potential investment opportunities and invest Fund assets in a “steady state” rather than maintaining a level of cash to facilitate daily redemptions. The Credit Opportunities Fund invests in lower-rated, less-liquid securities, which are riskier than higher-quality, more liquid investments. But for investors who examine and understand their liquidity needs, investment horizons, and tolerance for risk, the interval fund structure may prevent pulling capital in the face of market turbulence and turning “mark to market” losses into realized losses through forced sales.

An interval fund structure is not suitable for investors who need certainty about their ability to access all of the money they invest in the short term but may be a potential option for a long-term investment horizon. In addition, the fees and expenses associated with an interval fund structure are typically higher than those associated with other fund structures, such as open-end mutual funds.

In Summary

We believe the potential exists for ongoing episodes of credit market volatility due to structural changes that are not expected to change anytime soon. Looking ahead, we believe the Credit Opportunities Fund’s investment strategy that seeks to take advantage of dislocations across a full range of credit asset classes and sectors will be afforded ample opportunities. The Fund’s strategy navigated through the volatility of early 2020 and has historically produced returns ahead of the broad high yield bond market.

The interval fund structure allows for investments in less-liquid credit segments that offer the potential for higher long-term returns. But investors need to be mindful of the risks associated with the types of securities that the Credit Opportunities Fund invests in, which include lower-rated and illiquid securities, which are riskier than higher-rated, more liquid fixed-income issues. The interval fund structure does not provide daily liquidity for investors, which enables the manager to take a longer-term view on investments. And although the fund makes periodic offers to repurchase a portion of outstanding shares (typically quarterly), there is no guarantee that investors will be able to sell fund shares at any given time or in the quantity that they desire.

As with any investment, Investors should fully read all of the Fund’s available information, including its prospectus and most recent shareholder report, and consult with their financial advisors about the suitability of an interval fund in their portfolios. The Credit Opportunities Fund may be a potential solution for a long-term investment horizon.

 

Note that due to the interval fund structure, the Fund has limited liquidity and tends to have higher fees and expenses.

Interval Fund: An investment in an interval fund should be considered speculative and involves a high degree of risk, including the risk of a loss of some or all of the amount invested.

NOT FDIC INSURED–NO BANK GUARANTEE–MAY LOSE VALUE

Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.

Asset allocation or diversification does not guarantee a profit or protect against loss in declining markets.

No investing strategy can overcome all market volatility or guarantee future results.

The value of investments and any income from them is not guaranteed and may fall as well as rise, and an investor may not get back the amount originally invested. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.

Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

Important Credit Opportunities Fund Information:

The Fund is structured as an unlisted closed-end interval fund. Limited liquidity is provided to shareholders only through the Fund’s quarterly offers to repurchase between 5% and 25% of its outstanding shares at net asset value, subject to applicable law and approval of the Board of Trustees. The Fund currently expects to offer to repurchase 5% of outstanding shares per quarter. There is no secondary market for the Fund’s shares and none is expected to develop. There is no guarantee that an investor will be able to tender all or any of their requested Fund shares in a periodic repurchase offer. Investors should consider shares of the Fund to be an illiquid investment.

Although the Fund may impose a purchase fee of up to 2.00% on shares accepted for repurchase by the Fund that have been held for less than one year, the Fund does not currently intend to impose such a fee. Please refer to the Fund's prospectus for additional information.

The Fund’s ability to be fully invested and achieve its investment objective may be affected by the need to fund repurchase obligations. In addition, the fees and costs associated with investing in an interval fund may be significantly greater than those of other fund structures.

A Note about Risk

Credit Opportunities Fund: The Fund is subject to the general risks associated with investing in debt securities, including market, credit, liquidity, and interest-rate risk. The Fund may invest in high yield, lower-rated securities, sometimes called junk bonds. These securities carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. The Fund may invest in debt securities of stressed and distressed issuers as well as in defaulted securities and debtor-in-possession financings. Distressed and defaulted instruments generally present the same risks as investment in below-investment- grade instruments. However, in most cases, these risks are of a greater magnitude because of the uncertainties of investing in an issuer undergoing financial distress. 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. These factors can affect Fund performance.

Because of the risks associated with the Fund’s ability to invest in high yield securities, loans and related instruments and mortgage-related and other asset-backed instruments, foreign (including emerging market) securities (and related exposure to foreign currencies), and the Fund’s ability to use leverage, an investment in the Fund should be considered speculative and involving a high degree of risk, including the risk of a substantial loss of investment.

Collateralized Loan Obligations (CLOs) may involve a high degree of risk. CLOs are exposed to risks such as credit, default, liquidity, management, volatility, interest rate and credit risk. Special Situations includes distressed debt and other similar situations.

Equity Investing Risks

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies.

Fixed-Income Investing Risks

The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. 

The credit quality of fixed-income securities in a portfolio are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.

This material may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The views and opinions expressed are as of the date of publication, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions, and Lord Abbett disclaims any responsibility to update such views. Lord Abbett cannot be responsible for any direct or incidental loss incurred by applying any of the information offered.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

Please consult your investment professional for additional information concerning your specific situation.

Glossary Definitions

Bank Loans or Leveraged Loans are loans extended to companies or individuals that already have considerable amounts of debt. Lenders consider leveraged loans to carry a higher risk of default and, as a result, a leveraged loan is more costly to the borrower.

Convertible bond is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features.

Collateral Loan Obligation (CLO) is a special purpose vehicle (SPV) with securitization payments in the form of different tranches. Financial institutions back this security with receivables from loans. Collateralized loan obligations are the same as collateralized mortgage obligations (CMOs) except for the assets securing the obligation. CLOs allow banks to reduce regulatory capital requirements by selling large portions of their commercial loan portfolios to international markets, reducing the risks associated with lending.

Asset-Backed Security (ABS) is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, asset-backed securities are an alternative to investing in corporate debt.

Commercial Mortgage-Backed Security (CMBS) is a type of mortgage-backed security that is secured by the loan on a commercial property. A CMBS can provide liquidity to real estate investors and to commercial lenders. As with other types of MBS, the increased use of CMBS can be attributable to the rapid rise in real estate prices over the years.

ICE BofA Index Information:

Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofA 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 BofA 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 & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

The ICE BofA U.S. High Yield Index tracks the performance of U.S. dollar-denominated, below-investment-grade, corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below- investment-grade rating (based on an average of Moody’s, S&P, and Fitch), at least 18 months to final maturity at the time of issuance, at least a one-year remaining term to final maturity as of the rebalancing date, a fixed- coupon schedule, and a minimum amount outstanding of $100 million.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

This material is the copyright © 2021 of Lord, Abbett & Co. LLC. All Rights Reserved.  

Important Information for U.S. Investors

Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.

FOR MORE INFORMATION ON ANY LORD ABBETT FUNDS, CONTACT YOUR INVESTMENT PROFESSIONAL OR LORD ABBETT DISTRIBUTOR LLC AT 888-522-2388, OR VISIT US AT LORDABBETT.COM FOR A PROSPECTUS, WHICH CONTAINS IMPORTANT INFORMATION ABOUT A FUND'S INVESTMENT GOALS, SALES CHARGES, EXPENSES, AND RISKS THAT AN INVESTOR SHOULD CONSIDER AND READ CAREFULLY BEFORE INVESTING.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

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