Market Reviewas of 06/30/2015

Major themes in the second quarter that proved influential to emerging markets (EM) were a dovish U.S. Federal Reserve (Fed), the euro-reflationary trade, and rising core interest rates.

The second quarter started with euro appreciation following a substantial U.S. dollar rally, which began in the summer of 2014, up until March 2015. The U.S. dollar started to give back previous gains on disappointing U.S. growth in the first quarter, with gross domestic product (GDP) falling into negative territory and lower growth indications for the second quarter.  The Fed signaled that the timing of the first interest rate hike likely will be pushed farther back to September, which was a shift from the previously expected timeframe of mid-June. 

Europe saw stronger growth numbers this quarter and, most important, a pickup in inflation. The euro-reflationary trade was the predominant factor in the currency markets in April, when the euro strengthened against the U.S. dollar; however, EM currencies did not benefit because growth in the U.S. and China continued to disappoint. Overall, EM currencies traded sideways, depreciating slightly versus the U.S. dollar. 

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German bund rates hit a 10-year low in April, and have ­­increased 100 basis points since then.  U.S. rates generally have followed European rates, while EM local rates have risen, but not to the extent seen in the United States and Germany. 

Growth and inflation remained subdued throughout the EM universe during the quarter.  As a whole, EM central banks eased monetary policy slightly in the second quarter, but monetary easing was significantly reduced from the levels seen later in 2014 and the first quarter of 2015. There were not many EM-specific themes in the market this quarter, in terms of currency trading, but what likely aided performance was the market realization that the eventual rate hikes in the United States will be gradual. This effectively diminished some of the reactions of EM securities related to the Fed rate hike fears; it remains to be seen whether this trend will continue.

Toward the end of the quarter, Greece took center stage for many market participants as a market driver. Although emerging markets haven’t yet been affected significantly by Greek events, the potential exists for Greece to become a more important driver as the third quarter of 2015 commences.   

The asset class of EM local currency bonds (as represented by the JPMorgan GBI-EM Global Diversified Index1) returned  -0.95% in the three-month period ended June 30, 2015, compared with -3.96% in the first quarter of 2015.  

Fund Review as of 06/30/2015

The Fund returned -1.41%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the three-month period ended June 30, 2015. The Fund’s benchmark, the JPMorgan GBI-EM Global Diversified Index,1 returned -0.95% in the same period. The Fund’s 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: -18.87%; and since inception, June 28, 2013: -8.27%. Expense ratio, gross: 3.01%, and net: 1.05%.

Performance data quoted represent past performance, which is no guarantee of 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 888-522-2388 or visit us at www.lordabbett.com.

In general, our foreign currency exposure was the largest detractor to overall performance of the Fund. We maintained the Fund’s underweight positions in the euro and other currencies in countries such as Poland and Hungary; however, these currencies continued to appreciate despite European Central Bank (ECB) quantitative easing and concerns regarding Greece. We continued to position the Fund to benefit from improving domestic growth cycles in countries such as Mexico, Chile, and South Korea. However, the market did not reward improving growth prospects this quarter, and currency positions in these countries hurt relative performance. Indonesian bond positions hurt relative performance, as we anticipated flattening of the yield curve and were positioned in the longer end of the yield curve. Although the curve flattened initially, the curve ultimately steepened during the quarter, as inflation came in higher than anticipated and the market lacked confidence in the credibility of the Indonesian central bank.

The majority of the Fund’s bond positions benefited relative performance, particularly those in Poland and Turkey. In Turkey, the Fund was underweight the longer end of the yield curve, and in Poland we remained underweight across the curve; both positions performed well during the second quarter. As yields rose in German bunds, Polish bond prices fell to an even greater extent. Polish bonds recently had been trading with minimal risk premium to German bunds, and began widening when they stopped their easing cycle in March due to strong growth and increasing inflation. Although Poland is expected to be one of the first European nations to raise interest rates, the hike most likely will be pushed to 2016. Political uncertainty was the major driving force in Turkish bonds. Elections resulted in the end of a single party majority rule for the first time since 2002, which caused a drag on bond prices as yields rose, particularly in the long end of the curve. 

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

While Greece is likely to dominate financial headlines over the near term, we do not anticipate that Greek events will lead to a significant disruption in emerging market bond prices. We remain positive on emerging markets’ fixed-income rates, as markets become more confident in a gradual hike in U.S. interest rates. As a result, we do not anticipate a repeat of the “taper tantrum” that we saw in 2013, and emerging market interest rates should rise less than U.S. interest rates.

While many market participants anticipate steepening of the U.S. yield curve when rate hikes ultimately commence, we believe flattening is possible, as the pace of hikes will be gradual and inflation is not likely to pick up significantly. Thus, we are positioning for flatteners in several emerging market yield curves that tend to move with U.S. Treasuries, such as Mexico and Peru. Since U.S. rates will continue to be a driver of overall market movements, we may seek to reduce the Fund’s exposure to U.S. rates by using Treasury futures.

Short-term interest rates have become increasingly attractive for carry trades; thus, we anticipate that market participants may be willing to increase their currency exposure as hedging has become more expensive. This should lead to currency appreciation. We are likely to increase our weight in currencies, especially once some of the global macro risks start to dissipate. 

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