U.S. Ultra Short Plus Strategy

Hannah Rosencrantz: Hello and happy new year. Welcome to the fourth quarter in review for 2024 for the Plus Fixed Income team. My name is Hannah Rosencrantz, portfolio specialist on the team, and today I'm joined by head of and senior portfolio manager for the Plus Fixed Income team, Janet Rilling. Thanks, Janet, for being here.

Janet Rilling: Thanks, Hannah. It's a pleasure.

Hannah: Why don't we kick things off with a recap for viewers of Q4?

Janet: Sure. Well, fixed income markets did produce negative total returns for the quarter. That was largely driven by a shift upward in the yield curve. However, credit spreads did tighten. So, that did offset some of that move. Credit spreads are the compensation an investor receives for taking on additional credit risk. If you look across the fixed income space, however, it wasn't everything performing exactly the same way. Down-in-quality or lower-rated bonds performed better than higher quality. Shorter duration parts of the market outperformed the longer duration parts of the market. The drivers of the negative total return were really twofold. The first was the economic data. In general, it came out better than expected. Growth figures, for example, were a bit more elevated than the market or the Fed (Federal Reserve) expected. The employment market remained largely balanced. It really didn't soften too much. But inflation, that remained elevated. And that is a concern of the market and the Fed. So, that led to the second element, which was the Fed. The Fed did continue on its rate cutting cycle, which it began in the third quarter. It reduced rates two times in the fourth quarter. But at that December meeting, that 25 basis point rate cut actually had more of a hawkish feel to it as the Fed started telegraphing the fact that they were seeing the economic data be a bit more robust. As a result, the market adjusted its expectations for rate cuts in 2025, going from six down to two, and that as a result, led to the increase in the yield curve.

Hannah: Excellent. Well, thank you so much for that recap. Certainly, a challenging quarter for fixed income, but also some bright spots, as well. So, you did reference the Fed, as well as the adjustments, the downward adjustments in our expectations for their actions in 2025. As investors are probably all too familiar with, the Fed has certainly taken center stage as it pertains to fixed income conversations, particularly in the U.S. But given some of the shift in expectations, it seems like they may be kind of shifting into more of a supportive role in 2025. Can you maybe talk about this idea in a bit more detail and talk about what may be stepping into the void in 2025, as well?

Janet: Well, it's certainly true that the Fed has been the focus of the markets for the last several years. And that began first when the Fed started its rate hiking cycle. That was the fastest and the largest it's been in history. Then, we moved into a period of higher for longer. In other words, rates stayed high for a longer period of time than maybe people anticipated at the outset. And then, of course, in 2024, started the rate cutting cycle. So, the Fed was really the focus of not only the bond market but the equity market. Well, as we just talked about at the December meeting, the Fed has started to pull back on what it thinks it might do in terms of rate cuts in 2025. So, given that the Fed is more likely to be on hold for the next couple quarters, it does take some of the focus off of the Fed. Where is that focus going? Well, to the fiscal policy. We have a new administration. There's a lot of uncertainty regarding the policies that the Trump administration will be rolling out. And certainly, there is some rhetoric that has gone along with it. We think that's going to lead to more volatility and the markets will be much more focused on things like the tax policy, what's going on in regulatory policy, the potential for tariffs, and immigration. All of those feed into the growth picture, as well as inflation.

Hannah: Got it. So, while the Fed may not be completely out of the picture, certainly taking maybe more of a backseat in 2025. Why don't we finish things up with a bit of an outlook for 2025, as well as an update on positioning of our portfolios?

Janet: So, as we look at 2025, we are very constructive on the economy. Certainly, there was additional strength in 2024 that many didn't anticipate and we do see that continuing in 2025. That means the fundamental picture is good. That’s supportive of corporate credit. We see that credit metrics look pretty supportive. And also, default rates are on the lower end. So, that's a good backdrop. The technical picture looks good, as well. We've tested it already here in the beginning of January. A lot of issuance has come through the investment grade corporate market. It's cleared the market without really any hiccups. So, that's a positive sign. The fly in the ointment is valuations. We do see credit spreads being pretty narrow in the historical context, which means you're not being compensated as much for taking on that risk. The good news is overall yields are quite high in a historical context. So, an investor can really tilt more towards yield without having to reach down in quality and take on more of that credit risk. So, what we're thinking for 2025 is an up-in-quality tilt in portfolios. Don't give up the income, but do tilt to sectors that are more defensive and more up in quality. Things we're doing more specifically in the sectors, we’re overweighting structured product. Within structured product, we like agency mortgage-backed securities. The up-in-coupon part of that market is what we view as most attractive. We also like ABS, asset-backed securities. And then for credit, we are favoring European credit a bit over U.S. credit. That's both investment grade and high yield. But we're not at an overweight position there. We've just moved it more to a neutral position. So, all in all, we are constructive on 2025. We think higher yields, along with an up-in-quality tilt can be a good way to position a portfolio. We'll continue to focus, as we always do, on security selection, using our multiple levers to diversify the portfolio across the sectors and taking an unbiased approach in the management of the portfolio.

Hannah: Perfect. Well, thanks again for your time today and your thoughts. Looking forward to connecting with viewers again at the end of Q1.

Janet: Well, thanks for having me, Hannah. It's been a great conversation.