Market Review as of 03/31/2015

Major categories of U.S. fixed-income securities posted positive returns in the first quarter of 2015.  The market received a boost from the U.S. Federal Reserve (the “Fed”) when it reduced its projections for interest-rate hikes during 2015. While investors speculated on the precise timing of the Fed’s first rate hike, the European Central Bank pulled its policy in the opposite direction, launching a quantitative easing program under which it will buy €1.1 trillion in sovereign bonds over a 19-month period.

In a statement following its policy meeting on March 17–18, Fed data suggested that economic growth has moderated. Expectations that U.S. growth would accelerate had weighed on the U.S. Treasury market. The central bank said higher interest rates in April are unlikely and that it won’t tighten policy until it is “reasonably confident” inflation will return to its target and the labor market improves further.1 While the Fed dropped an assurance that it will be “patient” in raising rates in the statement following its policy meeting on March 18, the word’s removal doesn’t mean it will be impatient, said Fed chairwoman Janet Yellen at a press conference. Fed policymakers lowered their median estimate for the fed funds rate for the end of 2015, to 0.625%, from 1.125% in December 2014, but this is still indicative of rate hikes this year.2

The reduced Fed rate-hike expectations bolstered U.S. government debt. U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of 1.75% for the three-month period ended March 31, 2015. The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index4) gained 1.08%, benefiting from solid investor demand for tax-free securities, though supply concerns appeared to limit gains.

Credit-sensitive segments of the fixed-income market outperformed government-related securities in the first quarter. The high-yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index5) posted a return of 2.54% for the quarter, owing in part to a recovery in energy issues, which represent a significant part of the high-yield market. The floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index6) returned 2.07%, reflecting favorable fundamental and technical factors. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index7) returned 3.02%, benefiting from underlying gains in equities, particularly the mid-cap segment of the market.

Among higher credit-quality securities, investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index8) posted a return of 2.32%. Agency mortgage-backed securities (as represented by the Barclays MBS Index9) gained 1.06%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index10) returned 1.85%.

U.S. inflation remained dormant in the first quarter. In February, the overall Consumer Price Index (CPI)11 was unchanged over the prior 12 months, well below the Fed’s target of 2.0%.12 The index (excluding volatile food and energy prices) was also unchanged over the prior 12 months.

The U.S. labor market continued to strengthen in the first quarter. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 295,000 in February, above the average monthly gain of 266,000 over the prior 12 months, while the unemployment rate fell to 5.5%.13

Corporate credit quality generally remained consistent with an improving economic environment, though some strain was evident in the energy sector. The total amount of defaulted debt in the high-yield market was $4.5 billion in first quarter 2015, compared with $21.1 billion in the preceding quarter, which included the $18.1 billion Chapter 11 filing for Caesars Entertainment in December 2014. J.P. Morgan expects the default rate in the high-yield bond market to be 1.5% in 2015, rising to 3.0% in 2016, based on an approximate 10% default rate in the energy sector. These estimates are below the high-yield market’s average long-term default rate of 3.8%.

Fund Review as of 03/31/2015

The Fund returned 2.45%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended March 31, 2015. The Fund’s benchmark, the BofA Merrill Lynch All Convertibles, All Qualities Index,7 returned 3.02% 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 March 31, 2015, are: one year: 3.93%; five years: 8.66%; and 10 years: 6.21%. 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.

During the first quarter, selection within the energy sector detracted from the Fund’s relative performance.  In particular, the Fund’s overweight to Chesapeake Energy negatively impacted performance, as natural gas prices remained depressed and the firm’s production guidance relative to projected capital expenditures came in below analysts’ expectations. In addition, the Fund’s exposure to the technology sector detracted from performance relative to the benchmark index. Lackluster PC sales weighed down on semiconductors companies such as Micron Technology, which derives significant revenues from the industry.

The Fund’s relative performance in the first quarter benefited from continued mergers and acquisitions in the health care sector. In particular, an overweight to Salix Pharmaceuticals positively contributed to performance, as Valeant Pharmaceuticals acquired the company after outbidding a competitor. Additionally, strong security selection within the materials sector positively contributed to performance. The Fund benefited from its exposure to the titanium supplier RTI International Metals, which announced it would be acquired by Alcoa.

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

Our outlook for the convertibles market remains positive as credit spreads have relaxed from their widest points and are generally supportive of equities. We have taken profits in some of the strongest performers, particularly in the consumer discretionary and transportation sectors. Our lowered exposure to these sectors reflects our belief that many companies have outperformed the benefit they will receive in a lower commodity price environment. In addition, we maintain a positive bias in the biotechnology and specialty pharmaceuticals industries. While we remain disciplined with regard to price, valuations in these industries have continued to climb, as improving data and fundamentals have coincided with increased M&A activity.

We are focused on the Fund’s sensitivity to interest rates, as the Fed may look to increase short-term interest rates later this year. When considering the impact of interest rate changes, we look at both our Fund duration as well as our exposure to sectors that have historically had high correlations to interest rate movements.

We are encouraged by the approximately $16 billion of convertible issuance in the first quarter of 2015, up from $11 billion in the year ago period. The robust issuance has partly been driven by companies financing M&A transactions. Looking ahead, we expect to see higher issuance in sectors, such as energy, where companies find the lower cash cost of debt offered in the convertibles market to be more attractive in an environment where other forms of capital are too expensive. 

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