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Hartford Schroders Emerging Markets Multi-Sector Bond Fund

August 2018 Monthly Update

Performance (%)
% (as of 9/30/2018)
Average Annual Total Returns % (as of 9/30/2018)
YTD 1YR 3YR 5YR 10YR SI
Hartford Schroders Emerging Markets Multi-Sector Bond  I -6.10 -4.95 6.73 2.82 --- 2.92
Benchmark -4.23 -3.36 5.61 2.86 --- ---
Morningstar Emerging Markets Bond Category -4.27 -3.56 5.75 1.84 --- ---
Performance (%)
% (as of 9/30/2018)
Average Annual Total Returns % (as of 9/30/2018)
YTD 1YR 3YR 5YR 10YR SI
Hartford Schroders Emerging Markets Multi-Sector Bond  I -6.10 -4.95 6.73 2.82 --- 2.92
Benchmark -4.23 -3.36 5.61 2.86 --- ---
Morningstar Emerging Markets Bond Category -4.27 -3.56 5.75 1.84 --- ---
SI = Since Inception. Fund Inception: 06/25/2013
Operating Expenses:   Net 0.90% |  Gross  0.92%

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted.

 

Market Review

We are approaching, though not quite there yet, peak stress levels across emerging markets (EM) that were last seen in late 2015. EM turbulence returned in August, and negative headlines coming out of Turkey and Argentina have spread fears of contagion. The Argentine peso tumbled to a record low at the end of the month, prompting policy makers to raise the nation’s benchmark rate to 60% from 45%. The crash in Argentina comes during renewed uncertainty in Turkey, after a dramatic collapse earlier in the month. Turkey's refusal to address market concerns about its excessive growth rate and burgeoning current account deficit has proven to be a costly exercise for its citizens, and with a roughly 50% nominal depreciation of the currency and plummeting bond prices, local bondholders have effectively experienced a default. Banking stresses and perhaps bond restructurings are quite likely to follow, as will a boost to inflation while growth slows. One consolation for investors is that the current account deficit, the largest among big EM countries, will shrink, although in the most painful way possible.

More broadly, EM indices were impacted by the negative headlines in August. The J.P. Morgan EMBI Global Diversified Index, representing sovereigns, fell -1.73% for the month, and the J.P. Morgan GBI-EM Global Diversified Index, representing local currency, was unsurprisingly hit hardest returning -6.09%. EM corporate issues, as represented by the J.P. Morgan CEMBI Broad Diversified Index, were the best performing segment, down -1.08% for the month. In the corporate segment, investment grade issues returned 0.20% while high yield issues were down -2.62%. Asian corporates led all regions posting positive returns of 0.52%.  

 

Portfolio Positioning 

The Fund (Class I Shares) returned -3.74% in August, underperforming its blended benchmark (an equal weighting of the J.P. Morgan EMBI Global Diversified, J.P. Morgan CEMBI Broad Diversified, and J.P. Morgan GBI-EM Global Diversified Indices), which returned -2.96%, principally due to security selection within dollar-denominated sovereigns, which were the largest detractor during the month. This was predictably driven by our overweight to Argentine sovereigns, which were hurt by the sharp drop of the peso in August. Our issuer selection within dollar-denominated corporates was also a modest detractor, driven predominantly by our exposure to Turkish corporates. Our local currency underweight and currency hedges were the largest contributors in August as the local currency index was the worst performing portion of the blended benchmark. The Fund’s underweight to the Turkish lira in particular was the largest individual contributor. Additionally, our hedge of the Brazilian real aided returns and served to offset the negative contribution from the Fund’s overweight in Brazil. In August, the real went into a downswing, dropping more than 7%, as fears of contagion spread following the negative headlines out of Argentina and Turkey.

We continue to maintain a modest duration1 underweight posture. Additionally, we increased our hard currency exposure and decreased local currency exposure following a tumultuous month for local currencies. We remain underweight local currencies against the blended benchmark.  

 

Market Outlook

Recently there has been a steep rise in the spread between investment grade and high yield in EM, which is now about 40 basis points2 below the peaks of 2014 and late 2015 as the dollar made its steep ascent. Perhaps the most unusual feature of this episode of EM nerves is that dollar yields have done far poorer than local currency yields. The current spread of a just 8 basis points is far below the 100 basis point historical average, and at a level not seen since the global financial crisis. The good news for investors is that one need not take on currency risk and volatility to capture future mean reversion returns, but rather simply avoid default risk. It is at times like these that EM, with historical default rates of under 4%, embodies the behavioral finance maxim that markets consistently over-price worst case scenarios.

In the EM cycle of a strong dollar and declining global liquidity environment, we have moved to the point where weak fundamentals have been exposed (in countries like Turkey and Argentina), reflected in asset prices, and addressed fundamentally, although Turkey has much work to do despite a more stable currency.

While the decline in global liquidity has been reflected in EM prices, developed markets (DM) have emerged with nary a scratch. Over the last 12 months, the S&P 500 Index3 has outperformed the MSCI Emerging Markets Index4 by nearly 20% over the same period.

Should the international or EM stresses begin to affect the US fundamentally, the Federal Reserve (Fed) could hint the hiking cycle is winding down. This is what kicked off the very strong EM recovery from early 2016 through 2017. A slowdown in the US exacerbated by a too-strong dollar or a sharp equity correction for any reason could do the same. Negative trade war effects impacting the US would have a similar result.

Going forward, we expect there to be continued angst in EM as fundamentals wobble as a consequence of the liquidity cycle, but as in other cycles like the 2014-2016 episode, investors waiting for a massive blow up are likely to be disappointed. One of the potential triggers for ameliorating the negative effects, and eventually turning them around, will be a general recognition of the relative cheapness of EM versus DM, we believe. 

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Quarterly Fund Outlook & Commentary
Senior Investment Director John Mensack

Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.

2 A basis point a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.

S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.

MSCI Emerging Markets Index is a free float-adjusted market capitalization-weighted index that is designed to measure equity market performance in the global emerging markets, consisting of emerging market country indices.

Indices are unmanaged and not available for direct investment.

 

Important Risks: Investing involves risk, including the possible loss of principal. There is no guarantee a fund will achieve its stated objective. Security prices fluctuate in value depending on general market and economic conditions and the prospects of individual companies. ● Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. ● Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. ● Privately placed, restricted (Rule 144A) securities may be more difficult to sell and price than other securities. ● Derivatives are generally more volatile and sensitive to changes in market or economic conditions than other securities; their risks include currency, leverage, liquidity, index, pricing, and counterparty risk. ● Foreign investments may be more volatile and less liquid than U.S. investments and are subject to the risk of currency fluctuations and adverse political and economic developments. These risks may be greater for investments in emerging markets. ● The Fund may have high portfolio turnover, which could increase its transaction costs and an investor’s tax liability. The Fund may invest in a smaller number of issuers and focus on investments in particular geographic regions or countries, so it may be more exposed to risks and volatility than a more broadly diversified fund.

 

The views expressed herein are those of Schroder Investment Management North America Inc. (Schroders) are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. They may not reflect the views of Hartford Funds or any other sub-adviser to our funds and should not be construed as research or investment advice or as an offer or solicitation to buy or sell any security.

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