Sector views

---

Corporate debt: Investment grade and high yield

In investment-grade credit, it appears that a significant amount of good news has been priced in by the market. As of period-end, IG corporate spreads had tightened considerably, making valuations in this sector less attractive. Consequently, security selection and sector rotation will be of utmost importance as we navigate this market. [Spreads are the yield advantage credit-sensitive bonds offer over comparable-maturity U.S. Treasuries.]

Relative to other asset classes, high-yield bonds modestly lagged high-yield bank loans but outpaced the broad investment-grade fixed-income market. Looking first at high-yield bonds, we have a constructive intermediate-term view of corporate fundamentals and the market's supply-and-demand backdrop, although we expect the ongoing global health crisis to have an effect. Also, even though bond spreads retightened ollowing their sizable widening in March 2020, and compressed further on favorable vaccine news, we think valuations remain relatively attractive.

Trends in the mortgage market

Within the commercial mortgage-backed securities [CMBS] market, while there continues to be a degree of negative sentiment toward certain property types, the availability of Covid-19 vaccines has sparked optimism that social-distancing measures could be meaningfully eased by the middle of 2021. As a result, we continue to have conviction in our CMBX exposures. [CMBX is a group of tradeable indexes that each reference a basket of 25 CMBS issued in a particular year.] We believe current valuations fairly compensate investors for existing risk levels and provide an attractive risk premium.

Fundamental credit analysis and security selection are particularly important in the current CMBS market environment. While some parts of the CMBS market will likely continue to struggle, there are CMBS backed by what we consider to be strong underlying collateral that have suffered amid widespread fear of the sector. We think many of these bonds represent attractive investment opportunities.

Within residential mortgage credit, against the backdrop of robust home sales and a rebound in mortgage originations, we continue to find value across numerous market segments. In prepayment-sensitive areas of the market, we view agency IO collateralized mortgage obligations favorably, as well as inverse IOs backed by jumbo loans and more seasoned collateral. Overall, we consider prepayment-related opportunities as attractive sources of diversification.

In non-U.S. sovereign debt in both developed and emerging markets, we think the economic recovery will be strongest in countries with large service sectors and effective vaccine distribution. We also prefer countries that can contain government expenditures despite political pressures to raise them.