Past performance is no guarantee of future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here.
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The views expressed in this investment report represent the opinions of PNC Capital Advisors, LLC and are not intended to predict or depict performance of any investment. All information contained herein is for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation or recommendation to purchase any security. The information herein was obtained by various sources; we do not guarantee its accuracy or completeness. Fund performance quoted above is for class I shares. Past performance does not guarantee future results. These views are as of the date of this publication and are subject to change based on subsequent developments.
An investment in the Fund is subject to interest rate risk, which is the possibility that a fund’s yield will decline due to falling interest rates and the potential for bond prices to fall as interest rates rise. High yielding, non-investment grade bonds present a greater risk of loss to principal and interest than investment grade securities. The value of debt securities may be affected by the ability of issuers to make principal and interest payments and even the possibility that the issuer will default completely. Although U.S. government securities are considered to be among the safest investments, they are not guaranteed against price movements due to changing interest rates. The Fund may be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.
PNC Ultra Short Bond Fund (Share Class I) returned 0.92% in the second quarter versus a return of 0.94% for the benchmark, the ICE BofA Merrill Lynch 1-Year U.S. Treasury Index (the “benchmark”).
The Fund’s overweight allocations to the Corporate Credit & Asset-Backed Securities sectors, which outperformed, were the source of outperformance versus the benchmark, gross of fees.
The investment team continues to favor the Corporate Credit and Structured Product sectors due to favorable fundamentals and their relative value over the Treasury sector. The Fund has a duration position that approximates the benchmark.
Fixed Income Market Commentary
The unambiguously dovish tone from the Federal Reserve in the second quarter set the stage for a continued rally in both risky and risk-free assets. U.S. Treasury yields moved sharply lower, as expectations for “patience” from the Fed at the beginning of the quarter evolved to reflect an imminent reduction in the policy rate, likely at the July meeting. This considerable move lower in Treasury rates provided impressive returns for fixed income investors for the second consecutive quarter. The Bloomberg Barclays Aggregate Index produced a total return of 308 basis points (one basis point or bps is equal to 0.01%, or 1/100th of a percent) during the quarter, bringing the year-to-date return of the index to 6.11%.
The robust returns in fixed income markets reflected investor confidence that global central banks will follow through on the well-telegraphed pivot towards more accommodative policy. Despite concerns over slowing global growth and volatile trade negotiations, more dovish rhetoric from both the Fed and the European Central Bank provided a tailwind to risk assets. This leaves markets at somewhat of an inflection point to start the third quarter, as Treasury markets now imply two to three cuts over the remainder of this calendar year. The overall move in interest rates has been dramatic, with 3- to 7-year Treasury yields now roughly 130 bps lower from the highs of last November. Importantly, the negative slope of the yield curve between the 3-month Treasury bill and the 10-year Treasury note has persisted, which can be harbinger of a looming recession.
Risk assets are richly valued in our view, given the mixed outlook on earnings growth and the potential for a resurfacing of volatility in the second half of 2019. We believe tempered enthusiasm is warranted, as forward return expectations have moderated given the lower level of yields and spreads across the maturity and quality spectrum.
By mid-May, escalating trade tension with both China and Mexico, combined with weaker economic data, led Treasury rates lower, as the market dramatically re-priced expectations for a lower policy rate. At its June 19 meeting, the FOMC responded by carefully signaling a strong bias to lowering rates in order to sustain economic growth. The Committee highlighted concerns about slowing business investment and softening inflation measures. A generally more constructive view of trade talks following the G-20 Summit and the rebound in June payrolls alleviated some pressure on the Fed to move aggressively in the near term. However, the market is forecasting a near-certain 25 bps cut at the July meeting and as many as two additional reductions by the end of the year.
While monetary policy always serves as a primary influencer of financial conditions and sentiment, the substantial moves in global markets over the last several months puts even more focus on central banks to manage expectations. Given risks to the global economy and myriad geopolitical tensions, we are predisposed to maintain more defensive portfolio positioning. A more placid environment, in which yields stabilize and fundamentals improve, could support a further advance in risk assets. Given the binary outcome of these two scenarios, we are attentive to the likelihood for increased volatility, particularly as rhetoric intensifies entering the 2020 election cycle. The lack of compensation investors currently receive for taking incremental credit risk should reward a portfolio construction process focused on risk-optimization across sector, quality, and key rate durations.
Technical factors are likely to continue to be a meaningful driver of valuations and liquidity. The credit supply/demand balance has been skewed, with robust inflows from investors occurring simultaneously with diminished new supply from investment grade issuers (relative to the pace of prior years). This has aided spread compression in both primary and secondary markets, as investors search for incremental sources of yield in a lower interest rate environment.
Alternatively in MBS, technical factors have somewhat deteriorated, as the steep drop in U.S. Treasury yields has pushed refinancing activity higher. This environment has weighed on MBS valuations and has resulted in their returns lagging those seen in credit. We have used this opportunity to increase allocations to the sector across strategies, as relative valuations have become more compelling. Coupled with our expectations that MBS will perform favorably to credit in a flight-to-quality scenario, we view it as an attractive way to manage the risk/reward balance in clients’ portfolios.