Quarterly Update

Oct. 2018

Gregory S. Kaplan, Director of Fixed Income, Managing Director | Oct. 2018

Fixed Income Opportunities Remain Despite Rising Rates

Opportunities exist in short maturity assets

Demand for munis reflects cap on SALT deduction

We remain positive on higher quality taxable credit

The broad bond market as represented by the Bloomberg Barclays U.S. Aggregate Bond index lost further ground in Q3 (-1.6% YTD). The bellwether 10-year Treasury yield edged up about 20 bps and the Fed increased the overnight rate for the eighth time this cycle, making U.S. yields more attractive and supporting the dollar. Nevertheless, deceleration in Europe and China, plus trade and geopolitical uncertainty, have kept longer-term rate expectations in check. As the Fed Funds rate and the 10-year Treasury approach the theoretical neutral rate and the yield curve threatens to invert, City National Rochdale is looking to take advantage of the eventual turn in the interest rate cycle.

Municipal bonds edged lower in Q3 but have outperformed their taxable peers YTD as demand for the tax haven continued unabated, especially in high-tax states most impacted by the cap on the SALT deduction. Corporate bond spreads widened at the end of 2Q18 before tightening again in 3Q18 as the risk-on trade reemerged.

In the opportunistic space, U.S. Corporate High Yield has been a surprise performer (up nearly 2.6% YTD) as spreads on junk bonds have narrowed to 3.16% over U.S. Treasuries, the tightest since 2007. While further declines in default rates justify high valuations, City National Rochdale continues to believe that investors are not being compensated adequately for credit risk in this sector as the Fed enters the latter half of its hiking cycle.

Senior secured loans were also strong adding 2.1% in Q3 (+3.97% YTD) according to the S&P/LSTA Leveraged Loan 100 Index. Emerging market debt countered this trend driving most indices down, especially in the local currency sub-class. One notable exception has been in the short-maturity corporate EM space, where technical dislocations are providing a nice yield opportunity for high conviction credits.

We are aware that we are late in the cycle, when rates tend to peak. Therefore, we continue to be defensive but are ready to extend when we think the Fed overshoots. In the meantime, opportunities remain in senior secured loans, CLOs and short-duration EM, but we continue to carefully manage risk as the landscape changes.

Key Points

Opportunities exist in short maturity assets

Demand for munis reflects cap on SALT deduction

We remain positive on higher quality taxable credit

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Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.

Investments in Master Limited Partnerships (MLP) are susceptible to concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy, and market risk. Investors in MLPs are subject to increased tax reporting requirements. MLP investors typically receive a complicated schedule K-1 form rather than Form 1099. MLPs may not be appropriate investments for tax-advantaged accounts because of potential negative tax consequences (Unrelated Business Income Tax).

There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

Investments in emerging market bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging market bonds can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Returns include the reinvestment of interest and dividends. Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk. Past performance is no guarantee of future performance.

Index Definitions

The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.

The S&P/LSTA Leveraged Loan 100 Index (LL100) is a daily tradable index for the U.S. market that seeks to mirror the market-weighted performance of the largest institutional leveraged loans, as determined by criteria.

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

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