As of September 30, 2013
The high yield market seemed to be at the mercy of the U.S. Federal Reserve (the Fed) during the third quarter and what actions it would or would not take regarding its quantitative easing (QE)1 program. Interest rates on U.S. government bonds moved up dramatically after Fed Chairman Ben Bernanke announced the possibility of reducing its $85-billion-per-month bond buying program in June. We believe this reaction and mixed economic data prompted Bernanke to assure the public that QE would remain in effect until the economy was on more solid footing. The rise in rates on the 10-year U.S. Treasury Bond abated aft er this news.
In anticipation of rates rising, we continued to focus on overweighting shorter duration and B-rated bonds2 in the Pax World High Yield Bond Fund. Bonds that are shorter in duration and rated single B historically have been less affected by a rise in rates. Our strategy worked well for most of the quarter but worked against us as rates started to decline at the end of September. We were still able to outperform our benchmark, the BofA Merrill Lynch U.S. High Yield – Cash Pay – BB-B (Constrained 2%) Index,3 by 14 basis points4 for the three-month period ended September 30, 2013.
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1Quantitative easing is monetary policy used by central banks to stimulate a national economy. Typically, central banks implement quantitative easing by buying financial assets from commercial banks and other private institutions, injecting a pre-determined quantity of money into the economy.
2B rating is an S&P rating of bonds. An obligation 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.
3The BofA Merrill Lynch U.S. High Yield - Cash Pay - 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%. One cannot invest directly in an index.
4A basis point is a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.