Market Review as of 03/31/2015

Major categories of U.S. fixed-income securities posted positive returns in the first quarter of 2015.  The market received a boost from the U.S. Federal Reserve (the “Fed”) when it reduced its projections for interest-rate hikes during 2015. While investors speculated on the precise timing of the Fed’s first rate hike, the European Central Bank pulled its policy in the opposite direction, launching a quantitative easing program under which it will buy €1.1 trillion in sovereign bonds over a 19-month period.

In a statement following its policy meeting on March 17–18, Fed data suggested that economic growth has moderated. Expectations that U.S. growth would accelerate had weighed on the U.S. Treasury market. The central bank said higher interest rates in April are unlikely and that it won’t tighten policy until it is “reasonably confident” inflation will return to its target and the labor market improves further.1 While the Fed dropped an assurance that it will be “patient” in raising rates in the statement following its policy meeting on March 18, the word’s removal doesn’t mean it will be impatient, said Fed chairwoman Janet Yellen at a press conference. Fed policymakers lowered their median estimate for the fed funds rate for the end of 2015, to 0.625%, from 1.125% in December 2014, but this is still indicative of rate hikes this year.2

The reduced Fed rate-hike expectations bolstered U.S. government debt. U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of 1.75% for the three-month period ended March 31, 2015. The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index4) gained 1.08%, benefiting from solid investor demand for tax-free securities, though supply concerns appeared to limit gains.

Credit-sensitive segments of the fixed-income market outperformed government-related securities in the first quarter. The high-yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index5) posted a return of 2.54% for the quarter, owing in part to a recovery 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) returned 2.07%, reflecting favorable fundamental and technical factors. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index7) returned 3.02%, benefiting from underlying gains in equities, particularly the mid-cap segment of the market.

Among higher credit-quality securities, investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index8) posted a return of 2.32%. Agency mortgage-backed securities (as represented by the Barclays MBS Index9) gained 1.06%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index10) returned 1.85%.

U.S. inflation remained dormant in the first quarter. In February, the overall Consumer Price Index (CPI)11 was unchanged over the prior 12 months, well below the Fed’s target of 2.0%.12 The index (excluding volatile food and energy prices) was also unchanged over the prior 12 months.

The U.S. labor market continued to strengthen in the first quarter. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 295,000 in February, above the average monthly gain of 266,000 over the prior 12 months, while the unemployment rate fell to 5.5%.13

Corporate credit quality generally remained consistent with an improving economic environment, though some strain was evident in the energy sector. The total amount of defaulted debt in the high-yield market was $4.5 billion in first quarter 2015, compared with $21.1 billion in the preceding quarter, which included the $18.1 billion Chapter 11 filing for Caesars Entertainment in December 2014. J.P. Morgan expects the default rate in the high-yield bond market to be 1.5% in 2015, rising to 3.0% in 2016, based on an approximate 10% default rate in the energy sector. These estimates are below the high-yield market’s average long-term default rate of 3.8%.

Fund Review as of 03/31/2015

The Fund returned 1.58%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended March 31, 2015. The Fund’s benchmark, the Barclays U.S. Universal Index,14 returned 1.73% 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 March 31, 2015, are: one year: 2.98%; five years: 4.74%; and 10 years: 5.24%.  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.

The term structure of the Total Return Fund had a modestly adverse impact on relative performance for the quarter.  The Fund pursues a largely duration-neutral approach but was somewhat underweight intermediate maturities relative to shorter maturities during a period when Treasury yields were broadly lower and the yield curve flattened.  The portfolio’s diversified exposure to various higher yielding, credit-sensitive sectors of the fixed income markets, contributed positively to excess returns, however.  Although the corporate sector, as a whole, contributed to performance during the period, security selection within high grade corporate securities detracted from relative performance as certain energy-related downgrades negatively impacted performance during the period.

Although volatility increased throughout the fixed-income market in the first quarter as a potential rate hike approaches, the market environment over the period was generally supportive of risk assets, and most major sectors of the bond market produced positive returns. The Fund benefited from its overweight allocation to the corporate sector, which was one of the strongest performing sectors of the fixed-income market during the period. The Fund’s exposure to certain securitized sectors of the market also aided performance.  Most notably, the Fund benefited from its overweight exposure to collateralized loan obligations (CLO), which have offered attractive risk-adjusted yields.  In addition, commercial mortgage-backed securities (CMBS) exposure was a contributor to performance; as fundamentals remain consistent with an improving U.S. economy, spreads tightened accordingly. On balance, 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.

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

Market participants continue to monitor economic data and the wording of Fed policy statements to determine when the central bank may finally increase the target fed funds rate off the zero bound.  Although the Fed did remove the assurance that it could be “patient” in raising rates in the most recent statement on March 18th, this removal was accompanied by a change in their “dot-plot” projections, indicating a lowering of Fed expectations of future fed funds rates.  Median projection on the 2015 year-end fed funds rate was lowered to 0.625%, down from December’s 1.125% estimate.2  While their decision continues to be data dependent, and the exact timing of the first hike remains unclear, our expectation is for increased volatility in the near term as the normalization process begins.  However, what may prove to be more impactful than simply the timing of the first hike is the implementation strategy to follow.  We believe that the Fed has sufficient latitude with relatively strong employment data and weak inflation to normalize rates in a manner that remains supportive of overall market health.

Despite a weaker than expected job report for the month of March, where only 126,000 jobs were added15 compared to the 264,000 predicted16, the labor market remains much improved with headline unemployment at just 5.5%17, and an average of 261,000 jobs added per month over the last year.  On the inflation front, the Core Personal Consumption Expenditures Index (which excludes the volatile food and energy components) rose just 1.37% year over year through February18, remaining well below the Fed’s 2.0% target, potentially giving pause to any tightening of monetary policy.  Economic growth, as measured by gross domestic product (GDP), showed positive, yet tepid growth in the fourth quarter of 2014, increasing at an annual rate of 2.2%, down from the impressive 5.0% print in the third quarter.19 Although we do not explicitly forecast the data outlined above, our base case is for continued moderate growth of the economy and a fed rate hike in the second half of 2015.

We are monitoring the effects of continued dollar strength, sustained lower energy prices, and divergent global monetary policy on economic growth, and maintain a generally positive outlook for the U.S. economy.  Specifically, our medium-term outlook remains most constructive for credit-sensitive areas of the market; although in the near term, volatility due to central bank policy normalization may dominate any fundamental considerations.  Broadly speaking, we have reduced risk in our portfolios, and would potentially view any bouts of volatility as presenting the possibility for attractive investment opportunities.

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