Manager Commentary

As of March 31, 2012

How did the Fund perform for the period?
For the three-month period ended March 31, 2012, the Individual Investor Class and Institutional Class of the Fund had total returns of 5.20% and 5.28%, respectively, vs. 4.42% for the BofA Merrill Lynch U.S. High Yield BB-B (Constrained 2%) Index¹.

What factors contributed to the Fund’s performance?
Bond selection in the media and consumer non-cyclical sectors were drivers of outperformance for the period, followed closely by bond selection in the telecommunications and consumer cyclical sectors. Performance for these sectors was mixed last year, but as investors have been taking on more risk and searching for yield this quarter, they have been driving them up. An underweighting in the banking and automotive sectors detracted from performance.

Can you discuss any significant changes in the Fund’s positioning throughout the period?
We added new names to the portfolio and increased positions in existing names that had weakened in 2011 due to risk aversion. Many of those names were generally lower rated bonds or were from emerging or European markets.

We purchased Inversiones Alsacia SA, a Chilean bus company that was recently awarded new lines from the government, which also subsidizes the fares. We also added to our positions in Navios Maritime Acquisition Corp., a crude carrier tanker company that sold off due to the weakness in day rates; and Kennedy-Wilson, Inc., a global real estate management company that was able to acquire commercial properties in Europe at very favorable prices.

We took some profits by selling some of our position in Goodrich Petroleum Corp. as natural gas-weighted exploration and production (E&P) companies came under pressure, and later added them back at lower prices.

Which bonds contributed positively to performance?
The issuer with the greatest contribution to relative outperformance was Foodcorp Pty, Ltd., a South African manufacturer of branded and private-label food products ranging from basics such as oils and peanut butter to premade take-home convenience meals. Fundamentals are good but the bonds sold off last year mostly because they are emerging market debt and because they are denominated in Euros. The bonds rebounded this quarter.

Ply Gem Industries, Inc., a building products company, was our next best relative performer. The company has been taking market share in a difficult home building environment and participated in the higher beta² rally in the quarter. Equinix, Inc.,  a web-hosting, design company was also one of our top outperformers, benefitting  from increased internet traffic and the trend in corporate outsourcing of data center operations.

Which bonds detracted from performance?
Knowledge Learning Corp., the largest provider of private early childhood education, was our biggest detractor to Fund performance for the period. The bonds weakened shortly after Moody’s downgraded them one notch to B3³. Profits have been negatively affected by decreased enrollment and center revenues resulting from the poor economic environment and high unemployment rate. We believe the bonds are cheap at these levels and that we are getting paid for the risk. In addition, the company should benefit from improving employment data, in our opinion.

Goodrich Petroleum Corp. and Penn Virginia Corp., both exploration and development companies, underperformed mostly due to macro-related issues. The country experienced one of the warmest winters in recorded history⁴ resulting in crushed natural gas prices and buoyed inventories. We believe both companies will soon benefit from their strategies of increasing oil production and profiting from higher oil prices.

What is your market outlook, particularly with respect to how it will impact your Fund?
The high-yield market has posted positive returns of over 5% year-to-date as measured by the Lipper High Current Yield Funds Index⁵.  While we do expect positive returns to continue into the year, we don’t expect they will keep up with the pace of the first quarter. Although markets have benefitted from better U.S. economic data, we feel that the introduction of the Long-Term Refinancing Operations (LTRO) by the ECB last December led the rally. LTRO alleviated much of the concern associated with the European debt crisis by providing cheap liquidity to European Banks. This fueled higher beta trades during the first quarter as many investors felt more comfortable taking on risk.

We believe our portfolio is positioned to benefit from this environment due to our overweighting in single B⁶ names. Last year, due to risk aversion, the 10-year Treasury bonds⁷ outperformed most other asset classes. BB’s⁸ and other higher rated bonds followed suit. We believe this trading is complete as investors have exited the safety of the 10-year Treasury Bond and moved to higher beta trades. In addition, we expect that the Fund is well-positioned for any volatility that may occur in the coming months, given its lower risk metrics compared to both benchmark and peers.⁹

Equity investments are subject to market fluctuations, the fund’s share price can fall because of weakness in the broad market, a particular industry, or specific holdings. Yield and share price will vary with changes in interest rates and market conditions. Investors should note that if interest rates rise significantly from current levels, bond fund total returns will decline and may even turn negative in the short term. There is also a chance that some of the fund’s holdings may have their credit rating downgraded or may default. Emerging market and international investments involve risk of capital loss from unfavorable fluctuations in currency values, differences in generally accepted accounting principles, economic or political instability in other nations or increased volatility and lower trading volume. Derivatives involve special risks and may result in losses.

Portfolio holdings as of 03/31/12: Inversiones Alsacia SA (0.8%), Navios Maritime Acquisition Corp. (1.0%), Kennedy-Wilson, Inc. (1.6%), Goodrich Petroleum Corp. (1.6%), Foodcorp Pty, Ltd. (1.3%), Ply Gem Industries, Inc. (1.3%), Equinix, Inc.(0.4%), Knowledge Learning Corp. (0.9%), Penn Virginia Corp. (1.3%). Holdings are subject to change.

An investment in the Fund involves risk, including loss of principal. Performance data quoted represents past performance, which does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. To obtain performance for the most recent quarter- and month-end, click here.

As of 12/31/11, total annual High Yield Bond Fund operating expenses, gross of any fee waivers or reimbursements, are 0.97% for the Individual Class shares and 0.72% for the Institutional Class shares. Total annual High Yield Bond Fund operating expenses, net of any fee waivers or reimbursements, are 0.97% for the Individual Class shares and 0.72% for the Institutional Class shares. The High Yield Bond Fund’s investment adviser has contractually agreed to reduce the High Yield Bond Fund’s management fee to 0.50% until at least December 31, 2013. The High Yield Bond Fund’s investment adviser has contractually agreed to reimburse expenses (excluding Acquired Fund Fees and Expenses) allocable to Individual Class shares of the High Yield Bond Fund to the extent such expenses exceed 0.24% of the average daily net assets of the High Yield Bond Fund. This reimbursement arrangement will remain in effect through at least December 31, 2013.

¹The BofA Merrill Lynch U.S. High Yield BB-B (Constrained 2%) Index tracks the performance of BB- and B-rated fixed income securities publicly issued in the major domestic or eurobond markets, with total index allocation to an individual issuer limited to 2%. The benchmark of High Yield Bond Fund was changed to the BofA Merrill Lynch U.S. High Yield BB-B (Constrained 2%) Index effective June 30, 2010. Pax World believes the BofA Merrill Lynch U.S. High Yield BB-B (Constrained 2%) Index more closely corresponds to the investments of the Fund. Investors cannot invest directly in any index.

²Beta reflects the sensitivity of a Fund's return to fluctuations in its benchmark; a beta for a benchmark is 1.00: a beta greater than 1.00 indicates above average volatility and risk.

³B3 rating is a Moody’s rating of bonds. A short-term obligation rated 'B-3' is regarded as having significant speculative characteristics, and the obligor has relatively weaker capacity to meet its financial commitments over the short-term compared to other speculative-grade obligors.

⁴Source: National Oceanic and Atmospheric Administration (NOAA).

⁵The Lipper High Current Yield Funds Index tracks the results of the 30 largest mutual funds in the Lipper High Current Yield Fund Average. The Lipper High Current Yield Fund Average is a total return performance average of mutual funds tracked by Lipper, Inc. that aim at high (relative) current yield from fixed income securities, have no quality or maturity restrictions and tend to invest in lower grade debt issues. The Lipper High Current Yield Fund Index is not what is typically considered an “index” because it tracks the performance of other mutual funds rather than changes in the value of a group of securities, a securities index or some other traditional economic indicator. Investors cannot invest directly in any index.

⁶B rating is a S&P’s rating of bonds. An obligation rated 'rated 'B' is more vulnerable to nonpayment than obligations rated 'BB', but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment on the obligation.

⁷A 10-year Treasury yield is the market interest rate on U.S. Treasury bonds that will mature 10 years from the date of purchase.

⁸BB rating is a S&P’s rating of bonds. An obligation rated 'BB' is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to the obligor's inadequate capacity to meet its financial commitment on the obligation.

⁹Risk measured by Standard Deviation over a 3 year period.  Standard Deviation measures a Fund's variation around its mean performance; a high standard deviation implies greater volatility.  As of 3/31/2012, standard deviation for the Pax World High Yield Bond Fund (Ind Investor Class), its peer group (The Lipper High Current Yield Bond Average) and its benchmark (BofA Merrill Lynch U.S. High Yield BB-B (Constrained 2%) Index) were 6.87, 9.32 and 8.36 respectively.

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