Market Review as of 06/30/2015

Major categories of U.S. fixed-income securities posted negative returns in the second quarter of 2015.  The market continues to speculate on the timing of the U.S. Federal Reserve’s (the “Fed”) interest rate hikes with 15 out of 17 of the Fed’s own officials predicting a rate hike in 2015.  However, Fed Chair Janet Yellen and other Fed officials have reiterated that their decisions will continue to be data dependent, making markets increasingly sensitive to economic releases.

Following its policy meeting on June 16–17, the Fed released a statement suggesting that economic growth had expanded moderately following an anemic first quarter.  During the meeting, the Fed decided to keep the targeted fed funds rate at 0% to 0.25% and reiterated that it would not be appropriate to raise the target range until it sees further improvement in the labor market and is “reasonably confident” that inflation will move back to the stated objective of 2% annually over the medium term.1 Fed policymakers left the median estimate for the fed funds rate at 0.625% for the end of 2015, which implies a rate hike this year.2

The strong economic activity combined with investor sentiment that the Fed will raise interest rates this year was a headwind for debt of the U.S. government.  U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of -1.84% for the three month period ended June 30, 2015.  The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index4) likewise returned -0.97% on concerns of the Fed raising rates this year.

Credit-sensitive segments of the fixed-income market outperformed government-related securities in the second quarter, though fixed income markets generally produced negative returns. The high-yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index5) posted a return of -0.05% for the quarter. The floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index6) returned 0.79%, reflecting strong relative performance against other sectors of the fixed income market. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index7) returned 0.56%, benefiting from underlying gains in equities, in large part due to the recent increase in mergers and acquisitions activity.

Among higher credit-quality securities, investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index8) posted a return of -3.16%. Agency mortgage-backed securities (as represented by the Barclays MBS Index9) lost -0.74%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index10) returned -1.11%.

U.S. inflation entered positive territory in the second quarter. However, primarily driven by lower energy prices, the overall Consumer Price Index (CPI)11 was unchanged as of May 2015, over the prior 12 months, still well below the Fed’s target of 2.0%. The index excluding volatile food and energy prices was significantly higher at 1.7%.12

The U.S. labor market continued to strengthen in the second quarter. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 280,000 in May, above the average monthly gain of 251,000 over the prior 12 months, while the unemployment rate was unchanged at 5.5%.13

High-yield issuance is expected to remain strong for the remainder of 2015, given the current market conditions and relatively low yields.  Year-to-date, high-yield issuance has been $190 billion, down approximately 8% year-over-year.  Institutional loan issuance has hit $200 billion, down 33% on a year-over-year basis.  For 2015, J.P. Morgan Securities is forecasting totals of $340 billion and $400 billion in gross new issuance of high-yield bonds and institutional loans respectively.

Fund Review as of 06/30/2015

The Fund returned -1.50%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended June 30, 2015. The Fund’s benchmark, the Barclays U.S. Universal Index,14 returned -1.40% during 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 June 30, 2015, are: one year: -1.00%; five years: 3.85%; and 10 years: 4.78%.  Gross Expense ratio: 0.84%. Net Expense ratio: 0.68%. 

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.

Rising interest rates during the second quarter of 2015 weighed on the performance of fixed income assets. The portfolio was able to generate positive excess return from exposures to various credit-sensitive sectors of the fixed income market. Although the Fund generally maintains a duration-neutral approach, the portfolio had a small flattening bias during a period when Treasury yields broadly rose and the yield curve steepened overall. Thus, the term structure of the Total Return Fund had a modestly adverse impact on relative performance.

Early in the quarter, the Fund was generally overweight risk-assets, such as emerging markets debt and collateralized loan obligations (CLOs), as volatility was dampened due to a lower probability of a rate hike in June. Throughout the quarter, we reduced the Fund’s exposure to emerging markets debt as the asset class outperformed; we continue to maintain a slight overweight to emerging markets as spreads have widened. We maintained the Fund’s overweight to CLOs, which we believe continue to offer attractive risk-adjusted yields. Both of these allocations contributed positively to relative performance.

The Fund’s positioning and trading within the agency mortgage-backed securities (MBS) sector had a negligible impact on performance over the quarter. Within this sector, we continue to monitor the impacts of heightened volatility on prepayment uncertainty, and will continue to try to generate incremental value through tactical allocations. The Fund’s allocation to the investment grade corporate sector was a further detractor from relative performance. Despite continued fundamental strength within the sector, investment grade credit was one of the worst performing sectors for the quarter. Strong security selection within the corporate sector offset this negative effect.

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

Central bank policy around the globe continues to dominate the world of fixed income, and investors are closely monitoring key economic data for any indication that the U.S. Federal Reserve might have sufficient justification to reverse its historically easy monetary policy.  Official Fed projections are still indicating a rate hike sometime in 20152; however, market-implied projections continue to call for a later rate hike, as they have been for the past several years15.  Although the exact timing and pace of this tightening remain uncertain, our expectation is that volatility will increase through the initial rate hike, and that secondary and tertiary effects of raising rates, after being so low for so long, remains a source of potential uncertainty.

The Fed’s dual mandate currently allows them significant flexibility to act in a manner that is consistent with their accommodative language and extraordinary efforts to maintain financial stability.  Inflation remains below both the Fed’s target level and their intermediate-term expectation of 2.0% growth for the Personal Consumption Expenditures price index2.  Employment continues to strengthen, with headline unemployment at just 5.5%13, but we are watching closely for signs of increased wage pressure, which we believe can lead to future increases in broader inflation.  These factors, in conjunction with the Fed’s unwritten “third mandate” of financial stability, should outweigh near-term noise in allowing the Fed to be patient in their tightening of monetary policy.

We maintain a generally up in quality bias across portfolios emphasizing liquidity and flexibility, but continue to rotate sectors based on relative value opportunities while conducting fundamental research to find undervalued securities.  Broadly speaking, we still view credit-sensitive sectors of the market as representing attractive relative value, and offering the best investment experience in a potential rising rate environment.  Although we are monitoring the trend towards shareholder-friendly, debt-financed M&A and share buybacks, we believe the credit cycle remains in healthy condition.  However, consistent with the up in quality theme, we have reduced the overall risk profile of those exposures.

Contact a Representative