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. 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 and bond fund prices may decline as interest rates rise. High yield bond investing includes special risks. Investments in lower rated and unrated debt securities are subject to a greater loss of principal and interest than investments in higher rated securities. The values of mortgage-backed securities depend on the credit quality and adequacy of the underlying assets or collateral and may be highly volatile. 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. The Fund may invest in Derivatives. Derivative instruments include options, futures and options on futures. A small investment in derivatives could have a potentially large impact on the Fund’s performance. The Fund may be unable to terminate or sell a derivatives position. Derivative counterparties may suffer financial difficulties and may not fulfill their contractual obligations.
PNC Total Return Advantage Fund (Share Class I) returned 3.88% in the first quarter versus a return of 2.94% for the Bloomberg Barclays U.S. Aggregate Bond Index (the “benchmark”).
The Fund’s allocation to the High Yield Corporate Credit sector was the primary driver of positively impacted performance. The Fund’s overweight allocation to the investment-grade Corporate Credit sector, which outperformed, positively impacted relative performance. The underweight allocation to the Treasury sector, which underperformed, also positively impacted relative performance. Duration/Yield Curve did not have a material performance impact this quarter.
The investment team maintains an overweight allocation to investment-grade Corporate Credit, High Yield Corporate Credit, and Asset-Backed Securities sectors and underweight allocations to the Treasury, Non-Corporate Credit, and Mortgage-Backed Securities sectors. The Fund’s duration position approximates the benchmark.
Fixed Income Market Commentary
An increasingly dovish message from the Fed stoked risk appetites in the first quarter and helped reverse weak performance in the final months of 2018. U.S. Treasury yields have moved sharply lower over the last six months, as markets adjusted to a rapidly changing narrative from the Federal Reserve that suggested a likely end to the tightening cycle. Markets are becoming increasingly comfortable with moderate growth in the domestic economy, while the Fed attempts to avoid a late-cycle policy mistake that could negatively impact sentiment and growth.
The tenuous tone in credit markets during the fourth quarter deteriorated further following the December 19 FOMC meeting, which brought the fifth consecutive quarterly hike in the policy rate. Following the decision, accommodative financial conditions tightened, as investors fretted that the Fed was increasingly at risk of committing a policy error by becoming too restrictive. Just 16 days after the December meeting, Chairman Powell pivoted towards a much more patient stance on future policy decisions, which set the stage for a rally in risk assets.
While we believe the Fed’s dovish pivot was the primary driver of the improved technical backdrop for credit, the fundamental story was a little more varied. Some modestly disappointing economic data in the U.S. began to raise concerns about decelerating domestic growth, while concerns over global growth caused even more angst. Additionally, the relentless flattening of the U.S. Treasury curve, which culminated with a temporary inversion of the 3-month bill/10-year note spread at the end of quarter, raised anxiety levels further given the predictive nature of this recessionary indicator.
High-quality securitized assets (Agency MBS, ABS) provided positive excess returns, but they trailed Credit, largely as a result of the sectors’ relative stability during the volatile fourth quarter. We believe the stability of these asset classes at this stage of the economic/credit cycle is particularly attractive in protecting portfolios from bouts of episodic volatility, such as what we’ve witnessed over the last several quarters.
The Fed’s desire to remove itself from the lengthy list of potential sources of market volatility was clear throughout the first quarter. At both the January and March FOMC meetings, Powell reinforced a dovish message that emphasized patience and completely reversed the tightening bias that had been in place over the last couple of years. The market response was evident, not just in the robust performance of risk assets, but also in the rapid flattening of the yield curve, which resulted in inversions along short and intermediate maturities. Fed funds futures shifted to price in a greater than 50% probability of a rate cut by the end of 2019.
A primary concern for the Fed is a recent softening in inflationary pressures, with core personal consumption expenditure trending back below 2%. While average hourly earnings remain in a notable uptrend, broad inflation measures remain relatively subdued, despite the Fed’s stated willingness to support “symmetry” around a 2% target. Oil prices firmed, but remain below fourth quarter 2018 peaks, and the break-even spread on 10-year Treasury Inflation-Protected Securities remains below 200 bps (2.00%). Without a significant change in the economic backdrop, we expect the Fed will opt for a “time-out” and remain safely on the sidelines for the remainder of this year.
Within the structured product space, we maintain an overweight allocation to MBS and ABS in shorter styles and have reduced our underweight to MBS in core styles. We are finding increasingly attractive relative value opportunities in these sectors. Additionally, their defensive qualities are especially appealing given comparative spreads in other risk sectors, their suppressed volatility, and their superior risk/return characteristics.
Effective the close of business December 7, 2018, PNC Intermediate Bond Fund (“Bond Fund”) reorganized into PNC Total Return Advantage Fund (“Advantage Fund”). Each shareholder of the Bond Fund became a shareholder in the Advantage Fund. Additionally, Class C shares of the Advantage Fund were converted into Class A shares of the Advantage Fund.