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 High Yield Fund returned 4.07% in the quarter compared with 4.16% for the Lipper High Yield Funds Average. For the 12 months ended June 30, 2016, the fund returned 0.02% versus −0.20% for the Lipper High Yield Funds Average. The fund's average annual total returns were 0.02%, 5.53%, and 6.92% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2016. The fund's expense ratio was 0.74% as of its fiscal year ended May 31, 2015.
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The High Yield 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.
Although the fund generated strong gains, it underperformed relative to the benchmark. After a multiyear run as the top contributor, the energy sector was the largest relative performance detractor. During a dynamic commodity environment, the investment team actively repositioned the portfolio; adding to fallen angels (companies downgraded from investment-grade status) in the energy and metals and mining industries. These additions did not keep pace with distressed names in these sectors, but they leave us well positioned going forward. While our underweight to health care, a traditionally defensive segment, benefited results, credit selection in financials detracted. We have maintained an allocation to bank loans-which are senior in the capital structure and tend to be less volatile than high yield bonds-and an allocation in European high yield debt. Both asset classes failed to keep up with the rally in the U.S. high yield bond market.
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, but they could turn lower in 2017. Income demand is highly supportive for our asset class. As always, our focus in managing the fund is on delivering high current income while seeking to contain the volatility inherent in this market. Our team maintains a commitment to thorough credit research and risk-conscious investing, which has led to favorable longer-term returns for our shareholders over various market cycles.