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(As of 12/31/22) — The U.S. high yield sector recorded its first positive quarter after three consecutive losing quarters as investors became more optimistic that the previous aggressive Federal Reserve (the “Fed”) actions were taming inflation more quickly than expected. Softer than expected economic data in October and November gave investors hope that the Fed could slow its pace of tightening. In addition, the high yield sector saw strong retail inflows, but very little new issuance, which drove demand for outstanding issues and lifted prices. December reversed course, albeit much more muted, driven by outflows and commentary from Fed officials that was more hawkish than many expected. The JP Morgan Domestic High Yield Index ended the quarter at a yield to worst of 9.23%, down 63 basis points (bps) from the beginning of the quarter, but well above the record low of 4.22% in July 2021. The 10-year Treasury yield rose 6 bps to 3.88% and produced a positive return of 0.56% during the quarter while the S&P 500 Index posted a gain of 7.56%.

High yield funds snapped a streak of quarterly cash outflows that began in the 1st quarter of 2021, posting $7.3 billion of inflows in the 4th quarter. For calendar year 2022, high yield fund outflows were a record -$47 billion, compared to -$13.2 billion of outflows in 2021. Not surprisingly, high yield new issuance remained muted during the quarter with only $16.6 billion, which was the lightest volume since the March 2009 quarter and compares to the quarterly average of $117 billion over the last two years. According to JP Morgan, the Energy sector saw the largest issuance accounting for 19%, followed by Gaming/Lodging/Leisure (14.7%), and Transportation (12.7%).

As mentioned previously, the 10-year Treasury bond yield only rose 6bps from 3.82% to 3.88%, compounding the 80bps increase in the 3rd quarter. According to data from JP Morgan, the -0.94% loss for the CCC credit tier was the only negative return amongst the credit quality silos and underperformed the rest of the credit spectrum, with split BB-rated bonds performing the best (+4.81%) for the quarter. Returns by industrial sector in the U.S. high yield universe were nearly all positive during the 4th quarter. According to data from JP Morgan, the Metals/Mining sector was the best performer with a positive 7.94% return, and Broadcasting was the only sector to deliver negative returns of -0.23%.

According to data from JP Morgan, the U.S. high yield market’s spread to worst for the period was 511bps, 63bps tighter than the 3rd quarter and 55bps tighter than the 20-year historical average of 566 bps. The yield to worst for the high yield market at quarter end was 9.23%, above the 20-year average of 7.84%, and well above the 4.71% yield at the end of the December 2021 quarter.

(As of 12/31/22) — We are focused first and foremost on the Federal Reserve’s balancing act between taming inflation while avoiding a recession, economic weakness globally, continued supply chain disruptions, and the geopolitical uncertainty caused by the ongoing conflict in Ukraine. We are managing the Fund cautiously yet actively, focusing on higher-quality issuers with defensive business models and manageable credit metrics. We will continue to deploy cash in opportunities that we believe offer the most appealing risk/reward tradeoff with a bias toward shorter durations and less levered credits. Additionally, we believe bank loans offer a more defensive position as they provide senior positioning in the capital structure and less interest rate sensitivity due to their floating rate structures. Finally, while we continue to look for opportunities in convertible bonds and preferred stocks, the increased level of bond yields for traditional bonds/loans in conjunction with the increased volatility of the underlying equities makes these types of securities less appealing to us at this time. We ended the quarter with 128 positions, down from the previous quarter’s total of 131.