Market Reviewas of 12/31/2014

The fourth quarter was marked by a return of volatility across both developed and emerging markets (EM). The U.S. Federal Reserve (the “Fed”), added to the jittery investor mood by officially ending its asset purchases in October, which in turn generated speculation among investors as to the timing of the first interest rate hike as well as the duration of the next rate-hiking cycle.

Also adding to investor concern was the collapse in global oil prices, which affected inflation globally.  While good news for most of the world’s oil importers and consumers,  the fall in the price of oil was detrimental to those economies heavily dependent on oil exports, such as Russia, Colombia, and Norway. Currency markets reflected the circumstances, punishing the currencies of oil exporters severely. In response to the collapse in the ruble, the Russian central bank hiked interest rates by 9% in the fourth quarter, bringing yields across the curve drastically higher.

U.S. and European economic performance continued to diverge, as did respective central bank policies. U.S. economic data strengthened, solidifying the United States as the fastest growing developed economy, with positive momentum heading into 2015. European economic data continued to disappoint, especially on the inflation front, which moved further below the European Central Bank’s (ECB) target of 2%.  The ECB did begin an asset purchase program, including buying covered bonds and asset-backed securities. In anticipation of expected sovereign bond purchases, the market pushed core European yields lower, with shorter-term German bund yields falling below zero. EM monetary policies also continued to be divergent, as some countries (e.g., South Korea, Romania, and Peru) eased in response to lower inflation, while others (such as Brazil, Indonesia, Russia) hiked to defend their currencies. 

Most yield curves globally, including those within emerging markets, flattened during the quarter, although that masked some differentiation across countries, largely reflecting variations in their individual growth and inflation cycles.    Compared to the move in currencies, however, EM local bond yields were relatively well behaved, with the yield on the GBI-EM Index1 falling by 24 basis points (bps). The U.S. Treasury curve flattened significantly, as the yield on the two-year Treasury rose 10 bps versus declines of 32 bps and 45 bps, respectively, on the 10-year and 30-year bonds.

Emerging markets local currency bonds (as represented by the JPMorgan GBI-EM Global Diversified Index1) returned -5.71% in the three-month period ended December 31, 2014, compared with -5.66% in the prior quarter.   

Fund Review as of 12/31/2014

The Fund returned -6.34%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the three-month period ended December 31, 2014. The Fund’s benchmark, the JPMorgan GBI-EM Global Diversified Index, returned -5.71% 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 December 31, 2014, are: one year: -9.13%; and since inception: -7.29%. Expense ratio, gross: 5.09%, 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.

One of the largest contributors to performance in the fourth quarter was a broad-based currency hedge that helped alleviate a portion of the wide decline experienced in emerging market currencies. Being underexposed to euro-based currencies including Hungary and Poland, benefited the Fund, as these currencies depreciated significantly. In addition, the Fund’s underexposure to Nigerian bonds and underweight to its currency benefited performance. Nigeria experienced panic outflows from its local markets due to the fall in oil prices and uncertainty surrounding upcoming presidential elections, leading the central bank to raise interest rates and devalue the exchange rate.

Exposure to Russia was the largest detractor from performance, as both Russian bonds and the ruble continued an unprecedented slide due to economic sanctions and plummeting oil prices. While the Fund held a neutral position in Russian bonds, its overweight in the currency hurt significantly. In addition, the Fund’s exposure to corporate debt, particularly in Russia, was a detriment, as credit spreads relative to sovereign yields widened. Our underexposure to duration in Turkish bonds hurt performance, as the central bank continued to deliver mixed messages to the market. Despite tighter monetary policy at times during the quarter to support the currency, these central bank actions were often quickly followed by easing which, combined with anticipated lower inflation as a result of lower oil prices, led to falling yields overall.  Underexposure to duration in South Africa hurt performance, despite efforts in the latter half of the quarter to adjust the Fund to a longer-duration stance.

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

After an extremely challenging quarter for emerging markets, we believe there is reason to be optimistic in 2015. While the trend toward differentiation among emerging economies faltered as the decline in oil prices drove markets lower, we expect country divergences to return once we begin to see stabilization in the energy market. We continue to focus on countries that will, ultimately, benefit from the reduction in oil prices, taking into account those countries that may benefit indirectly. For example, although oil revenue is an important contributor to Mexico’s fiscal balance, the negative effect will likely be outweighed by the benefit to its substantial manufacturing sector.

The Fed’s actions are going to be critical in 2015 as we approach the long-anticipated U.S. interest rate hikes. We are positioning the Fund in preparation for these hikes, and will look to minimize our exposure to those bonds most highly correlated with U.S. Treasuries. We believe that interest rate hikes alone will not be enough to derail emerging market economies if such rate increases accompany an improving U.S. economic picture.

We are constructive on the future for emerging market currencies, and have positioned the portfolio to benefit from the potential for an improvement in relative values. While we were able to stave off a significant level of underperformance through currency hedges in the fourth quarter, we believe the sell-off has presented an attractive opportunity for currency appreciation and, therefore, have removed many of these hedges. 

Disinflation can be found in nearly all emerging market economies due to the fall in oil prices. We believe that lower bond yields will be supported by the reduction in inflation, as many countries that were most likely heading toward interest rate hikes will delay those plans. Similarly, many countries that were previously cutting interest rates might have occasion to resume those cuts. The key to progress is stabilization in financial markets; stabilization is highly dependent on the end of free-falling oil prices. 

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