Market Sector Update
- Spreads between high-yield bonds and Treasuries continued to widen during the fourth quarter. The market was influenced by investor concern about declining oil prices and the potential impact on high-yield energy borrowers. We do not believe the market fundamentals supported this view.
- The high-yield sector selling pressure related to energy prices was further exacerbated during the quarter by uncertainty about the Federal Reserve’s (Fed’s) potential plans for raising its key interest rate in 2015 and lingering concerns in the minds of some investors about high-yield valuations.
- Our investment process is based on research of the individual opportunities. We seek good risk/reward characteristics, particularly related to companies that we believe the market does not understand or which generate outsize yield related to their price.
- We believe that credit selection is the basis for above-average performance through a credit cycle and believe it to be preferable versus attempting to time the market or place macro bets.
- We believe that the negative market sentiment we saw during the fourth quarter that pushed yields higher resulted in potentially more favorable risk/reward relationships.
- Generally, gross domestic product (GDP) growth is favorable for the highyield sector because a stronger economy can boost borrower income.
- We do not foresee a wave of defaults on the immediate horizon. If oil prices do remain exceptionally low for an extended period, we believe most of the energy-related defaults would not occur until late 2016 or early 2017. However, we do not currently expect this to occur.
- Contingent on how the energy situation unfolds, we may increase our energy exposure if favorable opportunities emerge. The Fund has been underweight energy.
- We believe the speculation about the Fed’s monetary policy deliberations will continue to be a potential source of volatility within the sector. However, it is also our view that, within fixed income, high-yield is the best-suited category to perform in a rising- rate environment.
The opinions expressed in this commentary are those of the Fund’s manager and are current through December 31, 2014. The manager’s 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 mutual fund, the value of the Fund's shares will change, and you could lose money on your investment. An investment in the Fund 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 Fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. These and other risks are more fully described in the Fund's prospectus. Not all funds or fund classes may be offered at all broker/dealers.
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.