Market Review as of 06/30/2015

Major categories of U.S. fixed-income securities posted negative returns in the second quarter of 2015.  The market continues to speculate on the timing of the U.S. Federal Reserve’s (the “Fed”) interest rate hikes with 15 out of 17 of the Fed’s own officials predicting a rate hike in 2015.  However, Fed Chair Janet Yellen and other Fed officials have reiterated that their decisions will continue to be data dependent, making markets increasingly sensitive to economic releases.

Following its policy meeting on June 16–17, the Fed released a statement suggesting that economic growth had expanded moderately following an anemic first quarter.  During the meeting, the Fed decided to keep the targeted fed funds rate at 0% to 0.25% and reiterated that it would not be appropriate to raise the target range until it sees further improvement in the labor market and is “reasonably confident” that inflation will move back to the stated objective of 2% annually over the medium term.1 Fed policymakers left the median estimate for the fed funds rate at 0.625% for the end of 2015, which implies a rate hike this year.2

The strong economic activity combined with investor sentiment that the Fed will raise interest rates this year was a headwind for debt of the U.S. government.  U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of -1.84% for the three month period ended June 30, 2015.  The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index4) likewise returned -0.97% on concerns of the Fed raising rates this year.

Credit-sensitive segments of the fixed-income market outperformed government-related securities in the second quarter, though fixed income markets generally produced negative returns. The high-yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index5) posted a return of -0.05% for the quarter. The floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index6) returned 0.79%, reflecting strong relative performance against other sectors of the fixed income market. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index7) returned 0.56%, benefiting from underlying gains in equities, in large part due to the recent increase in mergers and acquisitions activity.

Among higher credit-quality securities, investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index8) posted a return of -3.16%. Agency mortgage-backed securities (as represented by the Barclays MBS Index9) lost -0.74%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index10) returned -1.11%.

U.S. inflation entered positive territory in the second quarter. However, primarily driven by lower energy prices, the overall Consumer Price Index (CPI)11 was unchanged as of May 2015, over the prior 12 months, still well below the Fed’s target of 2.0%. The index excluding volatile food and energy prices was significantly higher at 1.7%.12

The U.S. labor market continued to strengthen in the second quarter. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 280,000 in May, above the average monthly gain of 251,000 over the prior 12 months, while the unemployment rate was unchanged at 5.5%.13

High-yield issuance is expected to remain strong for the remainder of 2015, given the current market conditions and relatively low yields.  Year-to-date, high-yield issuance has been $190 billion, down approximately 8% year-over-year.  Institutional loan issuance has hit $200 billion, down 33% on a year-over-year basis.  For 2015, J.P. Morgan Securities is forecasting totals of $340 billion and $400 billion in gross new issuance of high-yield bonds and institutional loans respectively.

Fund Review as of 06/30/2015

The Fund returned -0.57%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended June 30, 2015. The Fund’s benchmark, the BofA Merrill Lynch All Convertibles, All Qualities Index,7 returned 0.56% 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 June 30, 2015, are: one year: -0.50%; five years: 10.19%; and 10 years: 6.05%. Expense ratio, gross: 1.11%, 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.

Security selection within the technology sector weighed on relative performance during the quarter. An overweight position in Twitter, Inc. was a notable detractor. The company’s convertibles and stock fell after reporting significantly lower advertisement revenue than previously projected and subsequently lowered their sales forecasts for 2015. In addition, the portfolio’s exposure to Micron Technology detracted from relative performance. Demand for Micron’s memory solutions sagged as personal computer sales remained sluggish and the company guided to weaker second half earnings.

An overweight allocation to Tesla Motors, Inc, contributed to relative performance. Tesla convertibles outperformed during the quarter on the announcement of a new line of stackable batteries for residential and industrial use as well as anticipation of the upcoming Model X launch.  The portfolio also benefited from strong security selection within the health care sector. In particular, convertibles issued by Gilead Sciences rallied sharply during the quarter. Revenues from the company’s Hepatitis C treatment exceeded analyst expectations amid worries of competitive pressures.

Please refer to www.lordabbett.com under the “Portfolio” tab for a complete list of holdings of the Fund, including the securities discussed above.

Outlook

We maintain a positive outlook for the convertibles market in the second half of the year as U.S. economic data continues to improve and we see early signs of a resurgent U.S. consumer.  We believe that this positive data affirms our view that the economic weakness in the first quarter was transitory in nature.  Looking forward, we remain positively disposed to the health care sector, particularly biotech and specialty pharmaceutical companies with late stage pipelines and near-term revenue acceleration.  We also maintain a positive bias within the consumer discretionary sector, particularly within industries levered to an improving U.S. housing market.    

M&A remains on pace for a record year.  According to PricewaterhouseCoopers, as of May 31, 2015, the U.S. saw M&A deals worth $875 billion for 2015, a 9% increase from the same time period last year.  We expect this trend to continue as companies use attractively-priced debt to consolidate their industries and accelerate earnings growth.    

Convertible security issuance remains strong as the first half of 2015 featured $26 billion of new issues in the U.S market.  We have seen a shift this year towards larger-cap issuers, primarily as a means to partially finance acquisitions.  Looking ahead, we expect convertibles issuance to continue to benefit so long as the robust M&A environment persists.  We are also monitoring the more troubled parts of the corporate debt markets, such as the energy and materials sectors, and expect companies to eventually turn to the convertibles market for lower cash rates of interest.

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