Market Review as of 12/31/2014

Key categories of fixed-income securities posted divergent performances in the fourth quarter of 2014. While investors had to contend with plummeting oil prices, dramatic currency devaluations, and renewed market volatility, their primary concern remained future policy moves by the U.S. Federal Reserve (the “Fed”). The central bank is widely expected to begin hiking interest rates in 2015, given signs of a strengthening U.S. economy.

In a statement following its policy meeting on December 16–17, the Fed replaced the language of “a considerable time” regarding how long it would maintain its zero-interest rate policy, saying instead that it could be “patient” before making any changes.1 Fed policymakers lowered their median estimate for the fed funds rate for the end of 2015, to 1.125%, compared with 1.375% in September 2014.2

U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of 2.28% for the three-month period ended December 31, 2014. The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index4) gained 1.33%, benefitting from solid investor demand for tax-free securities amid a tightening supply of available issues.

Certain credit-sensitive segments of the fixed-income market underperformed government-related securities in the fourth quarter. The high-yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index5) posted a return of -1.06% for the quarter, as investor sentiment appeared to be dampened by weakness 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) posted a return of -0.40%, reflecting lower appetite for credit risk amid the decline in energy prices and renewed market volatility. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index7) returned 1.62%, likely reflecting the relative strength of equities.

Among higher credit-quality securities, investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index8) posted a return of 1.77%. Agency mortgage-backed securities (as represented by the Barclays Mortgage-Backed Securities Index9) gained 1.81%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index10) returned 1.45%.

U.S. inflation remained well-contained in the fourth quarter. In November, the overall Consumer Price Index (CPI)11 increased 1.3% over the prior 12 months, below the Fed’s target of 2.0%.12 The index (excluding volatile food and energy prices) rose 1.7% over the prior 12 months.

The U.S. labor market showed signs of acceleration. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 321,000 in November, above the average monthly gain of 224,000 over the prior 12 months, while the unemployment rate held at 5.8%.13

Corporate credit quality generally remained consistent with an improving economic environment, though the total amount of defaulted debt increased. In 2014, 28 companies defaulted, affecting a total of $70.2 billion in bonds and institutional loans, a five-year high, and the second highest total on record, according to J.P. Morgan. However, the defaults of Energy Futures (totaling $36 billion) in April and Caesars Entertainment ($18.1 billion) in December accounted for 77% of the year’s total volume. Excluding these two defaults, high-yield default activity of $16.0 billion represented the lowest total volume since 2007. J.P. Morgan expects the default rate in the high-yield bond market to be 2.5% in both 2015 and 2016. These estimates are well below the high-yield market’s average long-term default rate of 3.8%. 

Fund Review as of 12/31/2014

The Fund returned -0.61%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended December 31, 2014. The Fund’s benchmark, the Credit Suisse Leveraged Loan Index,6 returned -0.37%, for 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 December 31, 2014, are: one year: -1.35%; three years: 4.77%; five years: 4.77%; and since inception (December 31, 2007): 3.98%. Expense ratio: 0.80%.

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.

During the quarter, higher credit quality outperformed lower quality, and the portfolio’s positioning across the credit curve detracted from relative performance. 

The largest detractors from absolute performance during the quarter were the energy and utility sectors. The media/telecom and health care sectors contributed the most to performance on an absolute basis.

The service and gaming/leisure sectors detracted the most on a relative basis. Security selection within each sector detracted from relative performance. The utility and metals/minerals sectors contributed to relative performance during the quarter. Despite detracting from performance on an absolute basis, the portfolio benefited from security selection within the utility sector. The portfolio’s allocation to high-yield bonds also detracted from relative performance, as the high-yield bond market underperformed the floating-rate loan market.

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

Following five years of a zero interest rate policy from the Fed, debt-market participants now are closely monitoring the Fed for any signal as to when it may begin to normalize interest rates.  In the most recent statement following its meeting on December 17, the policy-setting arm of the Fed, the Federal Open Market Committee (FOMC), judged that it could be “patient in beginning to normalize the stance of monetary policy.” However, following that December meeting, futures markets implied a fed funds rate of approximately 55 basis points (bps) by the end of next year, down from 75 bps following the Fed’s meeting in September.  Such investor expectations are consistent with FOMC’s “dot-plot” projections for the Fed funds rate, which came down 25 bps during that same period.  Fed chairwoman Janet Yellen repeatedly has indicated that any decision to tighten monetary policy will be data-dependent, leading investors to closely watch economic data releases, with a particular eye on labor market and inflation measures.

Labor market conditions improved gradually throughout 2014, with headline unemployment falling from 6.7% in December 2013 to just 5.8% in November 2014.14 Meanwhile, the most recent data for inflation showed only a 1.3% increase in price levels over the 12 months ended November 2014.15  Economic growth, as measured by gross domestic product (GDP), continued its impressive trend upward, with third quarter GDP increasing at an annual rate of 5.0%;16 further, Fed officials are predicting positive GDP growth of 2.6–3.0% in 2015 and 2.5–3.0% in 2016. The Fed will potentially have to balance an improving economy with low levels of inflation when deciding when, and to what degree, it normalizes monetary policy over the coming months and years.

Although potential headwinds to U.S. economic growth do exist in the form of slowing global growth, the continuing strength of the U.S. dollar, and uncertainty stemming from lower oil prices, our outlook for the U.S. economy still remains positive. Corporate fundamentals appear healthy, and both commercial and consumer lending activity has shown recent improvement.  Specific to fixed income, defaults remain well below long-term averages, and companies have taken advantage of the low interest-rate environment to extend their debt maturities. Although we are constructive on the economy, we are conscious of the possible impact that any Fed tightening may have on market liquidity.

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