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In the fourth quarter of 2013, fixed-income markets continued to be influenced by investor expectations about the fate of the U.S. Federal Reserve's quantitative easing (QE) program. Yields on longer-maturity Treasury issues climbed as the market anticipated the effect of a prospective "tapering" of the Fed's $85 billion in monthly purchases of Treasury securities and agency mortgage-backed securities (MBS), the focal point of the central bank's efforts to hold down long-term interest rates.
As many market participants expected, the Fed announced on December 18 that it would begin to taper its bond purchases at a "modest" pace, with reductions of $5 billion per month in its purchases of both agency mortgage-backed securities and longer-term Treasury securities.1 The Fed viewed improvements in economic activity and labor market conditions since its September policy meeting as "consistent with growing underlying strength in the broader economy."
The government sector continued to be pressured by investor fears about a sustained rise in interest rates. U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index2) posted a loss of 0.9% for the three months ended December 31, according to Bloomberg. In contrast, the municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index3) posted a return of 0.4%. The gain came despite continued outflows from tax free mutual funds, based on Investment Company Institute data.
Credit-sensitive segments of the fixed-income market continued to outperform interest rate-sensitive groups in the fourth quarter. The high-yield bond market (as represented by the BofA Merrill Lynch High Yield Master II Constrained Index4) posted a 3.49% return for the quarter. The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles Index5) posted a return of 6.02%, while the floating-rate loan market (as represented by the Credit Suisse Leveraged Loan Index6) returned 1.82%.
Agency mortgage-backed securities (as represented by the Barclays MBS Index7) returned -0.42%. Commercial MBS (CMBS) (as represented by the Barclays CMBS ERISA-Eligible Index8) returned 0.53%. Investment-grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index9) returned 1.52%.
Inflation measures remained subdued in the fourth quarter. In November, the overall Consumer Price Index (CPI)10 increased 1.2% over the prior 12 months, below the Fed's target.11 Excluding food and energy, the index rose 1.7% over the prior 12 months.
Labor-market data showed an uptick in U.S. employment growth. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 203,000 in November, above the average monthly gain of 195,000 over the prior 12 months, while the unemployment rate dropped to 7.0%, as labor force participation posted a slight improvement.12
Corporate credit quality remained consistent with an improving economic environment as the default rate in the high-yield bond market was expected to remain below 2% in 2014 and 2015, according to J.P. Morgan. These estimates are well below the market's average long-term default rate of 4.0%.
The Fund returned 3.32%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended December 31, 2013. The Fund's benchmark, the Barclays U.S. Aggregate Bond Index,13 returned -0.14% in the same period. A blended index of 60% BofA Merrill Lynch High Yield Master II Constrained Index,4 20% BofA Merrill Lynch All Convertibles, All Qualities Index,5 and 20% Barclays U.S. Aggregate Bond Index returned 3.26%. The blended index is more representative of the diversified nature of the Bond Debenture Fund than is the Barclays U.S. Aggregate Bond Index, which includes only investment-grade securities. Average annual total returns, which reflect performance at the maximum 4.75% sales charge applicable to Class A share investments and include the reinvestment of all distributions, as of December 31, 2013, are: one year: 2.61%; five years: 13.05%; and 10 years: 6.51%. Expense ratio: 0.96%.
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. To obtain performance data current to the most recent month-end, call Lord Abbett at 1-888-522-2388 or visit us at www.lordabbett.com.
Good credit fundamentals, historically low default rates, and investors' reach for yield continued to support the high-yield market. Within the portfolio's high-yield allocation, top performing names included media services company Affinion Group, Inc. and automotive parts company Stanadyne Holdings, Inc. Detracting from absolute performance were certain high-yield bonds within the metals and mining sector. The portfolio maintains an overweight in high yield versus the benchmark, as we remain positive on the high-yield market from a fundamental perspective.
Convertibles continued to post strong returns. Within the convertibles portion of the portfolio, holdings within the biotechnology and SaaS software sectors contributed to absolute performance. Certain capital goods convertible bond holdings also contributed to absolute performance, but to a lesser extent. Within the portfolio's convertible allocation, we continue to focus on companies with good prospects for improving earnings results.
Within the portfolio's investment-grade bond allocation, we maintained little to no exposure to U.S. Treasuries, which added to absolute performance as corporates outperformed Treasuries during the quarter.
Overall across the portfolio, among the industries that contributed the most to absolute performance were technology and electronics, energy, and health care. Among those that either detracted from absolute performance or contributed the least were foreign sovereign, real estate, and utilities.
Please refer to www.lordabbett.com under the "Portfolio" tab for a complete list of holdings of the Fund, including the securities discussed above.
The Federal Reserve Open Market Committee decided on December 18 to begin tapering its quantitative easing program. Modest improvement in job creation over the past several months, increased certainty about the federal budget, and an expected reduction in fiscal drag as a result of avoiding further sequestration motivated the Fed to announce a $10 billion reduction in its monthly bond purchases. The decision was largely discounted in the Treasury market, as yields were little changed on the announcement. An anticipated slow and deliberate tapering process should calm investors who are fearful that replacement buyers might not emerge quickly after the Fed begins to scale back its current $85 billion in monthly bond purchases.
We continue to see good fundamentals, low default rates, and low cost of capital supporting the high-yield asset class. The market also continues to be supported by accommodative monetary policy by central banks. Consequently, we continue to find good, relative value in investment-grade corporates versus Treasuries. We continue to use Treasury futures to hedge some of the duration of the portfolio. The convertibles sector has performed well year to date, and we believe it should continue to provide good value. We are still seeking additional attractive opportunities in that sector.
Performance data quoted is historical. Past performance is not indicative of future results. Current performance may be higher or lower than the performance 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 quarter-end, go to quarter ending performance on our Website or call Lord Abbett at (888) 522-2388.
1 The Fund’s dividend yield is shown without sales charges (at NAV) and with maximum sales charges (at MOP). The Fund’s dividend yield takes into account any fee waiver or expense limitation arrangements, if any. Without such fee waivers or expense limitation arrangements, the Fund’s dividend yield would have been lower. Information regarding any fee waivers or expense limitation arrangements applicable to the Fund is provided with the Fund’s expense ratio information.
2 The Fund’s unsubsidized dividend yield is shown without sales charges (at NAV) and with maximum sales charges (at MOP). The Fund’s unsubsidized dividend yield reflects what the yield would have been without the effect of fee waivers or expense limitation arrangements.