Market Review as of 12/31/2015

The U.S. municipal bond market (as represented by the Barclays Municipal Bond Index1) continued to advance in the fourth quarter, surpassing the returns of other notable asset classes during the period. While municipal bond supply remained ahead of the prior year’s pace, supply during the quarter remained relatively slow when compared with that of the fourth quarter of the prior year.

While many other asset classes experienced significant volatility during the period, individual investor demand for municipal bonds remained strong, as these bonds posted attractive returns on a relative basis. Consequently, municipal fund flows, based on information from Lipper U.S. fund flows, peaked towards the end of the fourth quarter. Longer-maturity municipal bonds outperformed shorter-maturity municipal bonds, and longer-maturity municipal bonds generally outperformed Treasuries of similar maturities during the quarter.

Lower-quality bonds generally outperformed higher-quality bonds during the fourth quarter, due to the incremental yield available in such credits. Generally, with the exception of Puerto Rico bonds, the high-yield municipal market outperformed investment-grade municipals. Excluding a few issuers, overall municipal credit quality remained stable in an economic environment marked by steady growth and low inflation.

High-profile issuers, such as Illinois, Puerto Rico, and New Jersey, continued to remain in the spotlight during the past quarter, as struggles over pension issues and the political constraints caused by budget-balancing activities endured. Subject to a few stipulations that need to be met in 2016, the Puerto Rico Electric and Power Authority (PREPA) reached an agreement with a large portion of its creditors to restructure its debt, leading PREPA to gain 23%, consequently making it the best performer within the Commonwealth for the year. Despite isolated pockets of distress, overall creditworthiness continues to improve, as most states’ finances experienced rising revenues, while maintaining balanced budgets. At the federal level, there was no new legislation that had a material impact on the municipal market. 

Fund Review as of 12/31/2015

The Fund returned 0.14%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the three-month period ended December 31, 2015. The Fund’s benchmark, the Barclays Municipal Bond Short 1-5 Year Index,2 returned 0.08% 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, 2015, are: one year: -1.54%; three years: 0.00%; five years: 1.12%; and since inception (December  31, 2008): 1.97%. Expense ratio, gross: 0.70%, and net: 0.65%.

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. You can obtain performance data current to the most recent month-end by calling Lord Abbett at 888-522-2388 or referring to www.lordabbett.com.

The strongest driver of outperformance was the Fund’s allocation to bonds in the lower tiers of the investment-grade range, as the demand for incremental yield during the period benefited these credits. Bonds with maturities five years and longer outperformed, as U.S. Federal Reserve (Fed) activity pressured short-term bonds. Consequently, bonds with maturities shorter than four years underperformed, as the yield curve flattened during the quarter. Bonds rated ‘BBB’ outperformed, as demand for incremental yield persisted during the quarter. Bonds rated ‘AAA’ underperformed, as this credit-quality level did not participate in spread tightening experienced by lower-quality bonds during the period. With regard to sectors, investor-owned utilities and the prepaid gas sectors outperformed, as both sectors offered attractive yields with strong underlying credits, while industrial development revenue and public higher education bonds underperformed. Industrial development bonds lagged due to their shorter duration profiles and exposure to commodity and energy sub-sectors, while public higher education bonds underperformed, as this sector primarily consisted of high-quality bonds, and consequently, did not participate in the demand for incremental yield during the quarter.

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

During the fourth quarter, amid global market volatility, municipal investors experienced strong performance when compared to many other asset classes. Demand picked up significantly in the fourth quarter, a reversal from the trend seen in prior quarters, as the combination of solid relative performance and a low-rate environment turned more attention toward municipal debt. Demand for municipals is likely to continue, as municipal yields continue to provide investors with compelling taxable-equivalent income, and default rates remain low, while overall creditworthiness continues to improve. Although supply in 2015 persisted at a relatively high level, compared with last year’s pace, new-issue supply slowed throughout the fourth quarter. It is likely that new-issue supply will revert to higher levels in the short-term, as issuers become more confident in financing bonds for infrastructure needs. 

While yield ratios of municipals to Treasuries are lower when compared with those of recent years, due primarily to recent outperformance across most maturities, it is likely that municipals will continue to outperform, given strong demand and positive credit characteristics of the market amid a low interest-rate environment. While lower-rated bonds have posted strong returns in past years, credit-quality trends suggest that lower-quality bonds could outperform in the quarters to come, as demand for incremental yield in a low interest-rate environment and steady economic growth amid low inflation have supported credit quality of municipal issuers. While the high-yield municipal market averted the pressures of the taxable high-yield market, the impact of activity in other markets in the future is expected to be followed closely. It is likely that longer maturities also will continue to outperform, given that the Federal Reserve increased short-term rates and, consequently, long-term rates are unlikely to see as much pressure as longer bonds may provide a significant income advantage to investors.

Many states have experienced rising revenues, with the exception of those states that are heavily dependent upon energy. Although a few high-profile issuers, such as New Jersey and Illinois, are hampered by challenges, including pension reform and funding of pension liabilities, which increases the likelihood of possible downgrades, it is important to focus on overall creditworthiness, which is expected to remain strong. States reliant upon the financial services industry will likely be monitored for negative trends in the upcoming months; however, with respect to the financial health at the state level, it is important to distinguish between the isolated challenges and the strong overall health of states.  While the dynamic of the municipal bond market has changed considerably over the past few years, municipal bonds overall have continued to offer the combination of a high credit-quality profile and strong tax-equivalent returns to investors. 

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