Market Sector Update
- The volatility in the Treasury market over
the first quarter has given us a window
into the type of volatility we could expect
over the next couple of years.
- The Federal Reserve (Fed) has stated the
desire to begin to normalize its interest
rate policy. Unfortunately, the weak U.S.
economy is not allowing them to begin
to raise rates as quickly as they might
like. The timing of the first fed funds rate
hike has been moved to later this year, if
not into next year.
- Economic weakness in most developed
countries has led to a strong flight-toquality
trade into the U.S. Treasury
market. This weakness is showing signs
of spreading to the U.S. economy.
- The strong flight-to-quality trade that the
bond market has witnessed over the last
several months should continue through
the rest of 2015. As long as this trade
remains intact, long duration Treasury
yields could remain relatively low.
- Earlier this year we lengthened the
duration of the funds we manage. We
did this by increasing our exposure to
longer-maturity Treasury bonds and
reducing our overweight positions at the
middle of the interest rate curve.
- It does not take much new news for the
market to make a significant move to
higher or lower rates. We think
investment-grade corporate credit offers
the best risk-adjusted spread cushion of
the major sectors in the high-grade
fixed income market. We have been
overweight corporates over the last few
years and plan to continue this
overweight position as we move
through 2015. With economic
conditions improving in the U.S., we
expect relatively stable corporate bond
spreads on investment grade bonds.
- The new normal appears to be
significantly less net new issuance of
mortgage-backed securities. As a result,
mortgage spreads continue to be tight.
Our mortgage holdings are structured
to experience less extension risk during
periods of rising interest rates. We
remain underweight Treasury bonds,
especially at the very short end of the
curve, and overweight high grade
spread product. We are committed to
seeking stable income at the best
- While the Fed still appears to be willing
to keep rates low for a long time, they
have indicated a growing desire to
begin to normalize monetary policy.
They have indicated the risk of higher
inflation is less of a concern than the
threat of renewed economic weakness.
- The market does not anticipate the
Fed to begin raising the fed funds rate
until late 2015. However, this is a very
volatile and data dependent
prediction. With the short end of the
yield curve anchored by the low fed
funds rate, we expect to see continued
volatility in the middle and longer end
of the curve.
- Even slight changes in the U.S.
economic outlook can have significant
short-term effects on longer duration
- In the past, sustained bond bear
markets have not been able to get
underway until the Fed tightening
cycle is imminent. We expect to keep
our duration neutral to our benchmark
over the next three months. We
anticipate continued demand for
spread product within the high grade
bond market. We are willing to take
additional credit risk when we believe
we are being compensated to do so.
The opinions expressed in this commentary are those of the Portfolio's managers and are current through March 31, 2015. The managers' views are subject to change at any time based on market and other
conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.
Risk factors. As with any fund, the value of the Portfolio's shares will change, and you could lose money on your investment. An investment in the Portfolio is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Portfolio may
fall as interest rate rise. These and other risks are more fully described in the Portfolio's prospectus.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing
this and other information for the mutual funds offered by Waddell & Reed, call your financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary
prospectus carefully before investing.