The high yield market, as measured by the Bank of America Merrill Lynch High Yield Master II Constrained Index, was up 1.88% for the month of July. High yield recovered some of the sell-off experienced in May and June as Treasury yields stabilized and mutual fund and ETF (exchange traded fund) flows turned positive. The market's rally occurred as rate fears subsided, which resulted in retail flows returning to the asset class.
Recent data, taken together, suggest that the economy continues to expand at a steady, yet unspectacular, pace. The path for policy that Chairman Bernanke has laid out over the past two months appears to be on track. Second quarter (Q2) of 2013 gross domestic product (GDP) surprised to the upside as the Bureau of Economic Analysis reported that the U.S. economy grew at an annualized rate of 1.7% (Consensus: 1.1%). However, the positive surprise in Q2 was offset by downward revisions to the previous four quarters. On balance, the stronger-than-expected Q2 figure suggests the economy is on better footing after weathering the worst of the fiscal drag and appears primed to accelerate over the rest of the year. The ISM (Institute of Supply Management) Manufacturing Index jumped by over 4 points to 55.4 in July after the index hovered around the 50 point mark for the past four months. Some of the strength probably reflects anomalous seasonal factors, but strength in the production and new orders sub-indexes point to a pickup in activity in the second half of the year. The U.S. labor market continues to improve, albeit at a very modest pace. The Bureau of Labor Statistics reported that the economy created a less-than-stellar 162k new jobs in July with backward revisions of -26k to the prior two months figures. The unemployment rate dropped 0.2% to 7.4%. But some of the drop was due to the decline in the labor force participation rate, which fell 0.1% to 63.4%.
From a sector perspective, an overweight and positive issuer selection in the Telecom-Integrated Services sector contributed the most to relative performance during the month of July. An overweight and positive issue selection in the Gaming sector also contributed to relative performance during the month. Finally, we are still positive on the Housing sector. Although concerns about the robustness of the recovery are warranted, we believe that they are premature. The most recent reported housing data continues to be characterized by lean inventories, strengthening housing demand and home price appreciation. Thus far, every homebuilder that has reported earnings maintained its bullish stance, indicating that macro fundamentals of the housing sector remain on track for recovery. Over the next two years we see factors such as rising rents, historically high affordability, pent-up demand and job growth as outweighing higher mortgage rates as drivers for housing demand.
From a ratings perspective, our overweight and positive issue selection in CCC-rated issuers had the largest positive impact on relative performance during the month of July, followed by our overweight to B-rated issuers. Our 10% allocation to Leveraged Loans has helped relative performance over the past 3 months.
We remain constructive on the high yield market, and the U.S. economy. Global volatility and rising interest rates have the potential to slow U.S. growth, though we expect the U.S. economy to be resilient. The Housing, Energy, and Automotive sectors could all help support U.S. economic growth. The Fed is still in a stimulative posture with the clear history of resuming stimulus if it appears necessary. (Federal Reserve policymakers continue to stress that the full course of the plan for asset purchases is “data dependent.”) The current state of credit fundamentals, alongside a slowly improving economic backdrop, is consistent with our outlook for a low-default high yield environment.
High yield bonds are subject to greater price volatility and may be less liquid than higher rated securities; are subject to greater sensitivity to interest rate and economic changes. As interest rates rise, the value of debt securities decreases; whereas prepayment risk tends to occur during periods of declining interest rates. The decline in an issuer’s credit rating can negatively affect the value. International investing involves certain risks and increased volatility not associated with investing solely in the U.S. These risks include currency fluctuations, economic or financial instability, and lack of timely or reliable financial information or unfavorable political or legal developments. These risks are magnified in emerging markets. Distressed securities are speculative.
Investors should carefully consider the investment objectives, risks, charges and expenses of each Fund before investing. This and other important information is contained in the Nomura Partners Funds, Inc. prospectus, which may be obtained by contacting your financial advisor, by calling Nomura Partners Funds at 1-800-535-2726, or visiting our website at www.nomurapartnersfunds.com. Please read the prospectus carefully before investing.
The Bank of America Merrill Lynch U.S. High Yield Master II Constrained Index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market. One cannot invest directly in an index.
This material contains the current opinions of the author, which are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information used to compile this report has been obtained by sources deemed to be reliable, but its accuracy and completeness are not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Past performance is no guarantee of future results. There is a risk of loss.
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