U.S. high yield bonds generated strong second-quarter gains, extending the rally that began in mid-February. Market disruptions, most notably in June around the UK referendum, were mostly short-lived. Energy, metals and mining, and lower-quality issuance outperformed, with each of these segments posting double-digit gains. Default activity declined in the second quarter from a two-year high at the onset of the year. However, the year-to-date default total has already surpassed the full-year total for 2015. According to J.P. Morgan, more than 80% of the default activity has been in commodity-related issuers.
The Credit Opportunities Fund returned 3.89% in the quarter compared with 5.52% for the Barclays U.S. High-Yield 2% Issuer Capped Bond Index. For the 12 months ended June 30, 2016, the fund returned −3.80% versus 1.65% for the Barclays U.S. High-Yield 2% Issuer Capped Bond Index. The fund's 1-year and Since Inception (04/29/2014) average annual total returns were −3.80% and −3.48%, respectively, as of June 30, 2016. The fund's expense ratio was 1.89% as of its fiscal year ended May 31, 2015.
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The Credit Opportunities Fund charges a 2%
redemption fee on shares held 90 days or less.
The performance information shown does not reflect the deduction of the redemption fee;
if it did, the performance would be lower.
Over the quarter, the fund rotated into higher-quality bonds, mostly in the energy sector, where we added fallen angels (investment-grade bonds that have been downgraded to high yield status), which benefited portfolio performance. Even with our selective additions, the portfolio remained underweight to the energy sector and, to a lesser extent, in metals and mining, relative to its benchmark index. Although both sectors generated strong absolute gains, the underweight allocations and credit selection were significant relative performance detractors. Our bank loan allocation remains our largest off-index exposure as we have uncovered value in the asset class. Several factors benefit bank loans, including their seniority in the capital structure and their low sensitivity to rising interest rates. Our overweight allocations in services and utilities posted good results but outperformed entirely due to credit selection.
The majority of companies in the asset class appear to be in good financial shape, and we believe that the U.S. economy will continue to generate stable, albeit modest, growth in 2016. However, we expect that defaults will continue to rise in commodity-related sectors this year, though they could turn lower in 2017. Demand for high-yielding investments is highly supportive for our asset class. Our goal is to deliver high current income and attractive total returns over time while seeking to cushion the volatility inherent in our market. Diversifying sectors, including bank loans, and selectively participating in distressed or special situations should continue to add value. We remain committed to our rigorous research efforts and to constructing a diversified portfolio, which we believe is prudent for a fund that invests in a riskier area of the bond market.