By Thomas H. Ehrlein
- We continue to favor opportunistic income over core fixed income
- Return expectations should be modest, in line with coupons (5-6%)
- Periods of volatility are likely, but returns should correlate with economic growth
While corporate high yield bonds traditionally account for a large component of fixed income investment portfolios, there are many other ways to allocate assets for investors seeking opportunistic income in the taxable space. City National Rochdale takes a top-down approach when reviewing opportunities in yield-based asset classes, also evaluating alternatives to traditional investment grade bonds such as senior secured loans, asset-backed securities, and emerging market debt. Here's a look at current conditions in some of these categories:
U.S. corporate high yield: Leverage ratios remain stable among issuers, but we have been reducing our positions based on prospects in other areas. High yield credit spreads have been range-bound for the past 15 months, but we began reducing weights and allocating to other asset classes in Q3 2017. We believe defaults and economic conditions are a greater predictor of performance for this class than a rising rate environment.
Senior secured bank loans: Yields are comparable to U.S. corporate high yield, with lower interest rate risk and higher positions in companies' capital structures. Spreads have trended slightly downward over the past year, but because rates on these loans are floating (they are tied to the 3-month LIBOR rate), yields have risen in this asset class. Historically, default rates have been low in this space, but investors should be aware that default potential is increasing, as shown by the recent bankruptcies of Toys “R" Us and iHeartMedia. Bank loans are less impacted by rising rates – the focus is on credit analysis.
Emerging market debt: We see interesting opportunities here, in both corporate high yield and local currency sovereign debt. High growth rates in emerging market economies, combined with improved liability management and structural reforms, have led us to continue allocating capital toward this asset class. Reasonable debt levels and potential headwinds for the U.S. dollar are other reasons to consider opportunities in emerging markets.
These viewpoints and strategies are implemented through the City National Rochdale Fixed Income Opportunities Fund (RIMOX).
Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors.
The Bloomberg Barclays US Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon, and vintage.
The JP Morgan Corporate Emerging Market Bond Index tracks bonds in emerging markets and limits the weights of those index countries with larger debt stocks by only including a specified portion of these countries' eligible current face amounts of debt outstanding.
The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.
The S&P/LSTA Leveraged Loan Index is a capitalization-weighted syndicated loan index based upon market weightings, spreads, and interest payments. It covers the U.S. market back to 1997 and currently calculates on a daily basis.
The JP Morgan Global Bond Index-Emerging Market Global Index is an investable benchmark that includes only those countries that are directly accessible by most of the international investor base. It excludes countries with explicit capital controls but does not factor in regulatory/tax hurdles in assessing eligibility.
An investor should consider carefully the fund's investment objectives, risks, charges, and expenses. The Fund's summary and full prospectus contains this and other important information about the investment company, and it may be obtained by calling 800-245-9888. Please read it carefully before investing.
This material represents the manager's opinion regarding the market. It should not be regarded as investment advice or recommendation of specific securities.
Investing involves risk including loss of principal. Investing in international markets carries risks such as currency fluctuation, regulatory risks, economic, and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Bonds and bond funds are subject to interest rate risks and will decline in value as interest rates rise. Investing in securities that are not investment grade offers a higher yield but also carries a greater degree of risk of default or downgrade and are more volatile than investment grade securities due to the speculative nature of their investments.
Risks associated with bank loans include (i) prepayment risk which could cause the Fund to reinvest prepayment proceeds in lower-yielding investments; (ii) credit risk; and (iii) price volatility due to such factors as interest rate sensitivity and liquidity.
Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets.
Investment products are not bank deposits or obligations of or guaranteed by City National Bank or any subsidiary or affiliate and are not insured by the FDIC, they involve risk, including the possible loss of principal.
City National Rochdale Funds are distributed by SEI Investments Distribution Co., which is not affiliated with City National Bank or any of its affiliates, or any of the sub-advisors. SEI Investments Distribution Co., 1 Freedom Valley Drive, Oaks, PA, 19456.
The Morningstar RatingTM for funds, or “star rating," is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The Morningstar Rating does not include any adjustment for sales loads. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. As of 3/31/18, RIMOX was rated against 255 Multisector Bond Funds over three years and 205 over five years and received 5 star ratings over both respective time periods. Other share classes are available that may have different ratings.
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