Income Fund (Class Y)  (PNCYX)

The fund’s class Y shares returned -0.85%, trailing the 3.15% gain of the benchmark Bloomberg Barclays U.S. Aggregate Bond Index.

After a relatively quiet first two months of the new year, the market environment changed dramatically in March. Rapidly growing concerns about the economic impact of a coronavirus outbreak sparked a global sell-off in risk assets. The sharp turn in sentiment reverberated across markets, as global equities fell, developed-market government-bond yields declined, and credit spreads widened. A dispute between Russia and Saudi Arabia over oil production levels further unnerved investors. Due to heightened oil market uncertainty, U.S. crude prices dropped more than 66% during the quarter to $20.48 per barrel on March 31. The rapid decline in oil prices added considerable pressure across corporate supply chains.

An escalating economic crisis elicited unprecedented measures from policymakers. The Trump administration signed a roughly $2 trillion stimulus package into law — the largest economic relief package in U.S. history. The U.S. Federal Reserve rapidly unveiled six new lending facilities designed to help corporations facing a cash flow crisis avoid defaulting on their debt. These programs also provide support for money market funds and commercial debt markets. Dozens of other central banks across Europe, Asia, and elsewhere also announced emergency stimulus measures. Markets that were most directly influenced by this policy support stabilized during the final week of the quarter. Investors were hopeful that massive government stimulus programs would help offset the severity and duration of an economic recession.

A flight to safety pushed the yields on U.S. Treasuries lower. The benchmark 10-year Treasury yield plunged to a closing low of 0.54% on March 9 and ended the quarter at 0.70%, after beginning the year at 1.88%. The spreads on investment-grade bonds, or the risk premiums investors demand to hold these securities rather than U.S. Treasuries, widened to levels not seen since the financial crisis.

Within mortgage credit, our synthetic exposure to commercial mortgage-backed securities (CMBS) via CMBX was the biggest relative detractor for the period. CMBX is an index that references a basket of CMBS issued in a particular year. The fund’s allocation to CMBX tranches rated BBB and A performed poorly as spreads widened substantially. (Bond prices fall as spreads widen and rise as spreads tighten.)

Strategies targeting prepayment risk also worked against performance versus the benchmark. Lower interest rates and indiscriminate selling by investors proved to be material headwinds for our positions in agency interest-only collateralized mortgage obligations (IO CMOs) and inverse IO securities. The negative result here was partially offset by favorable tactical mortgage basis positioning. Mortgage basis is a strategy that seeks to exploit the yield differential between 30-year agency pass-throughs and 30-year U.S. Treasuries.

The fund’s interest-rate and yield-curve strategy aided relative performance. We positioned the portfolio to have greater-than-benchmark sensitivity to the movement of short-term interest rates. This proved beneficial as short-term rates declined more than longer-term rates during the quarter.

The fund’s underweight allocation to investment-grade credit also added value, especially in March amid intensifying negative market sentiment and widening spreads.

As the period concluded, the number of coronavirus infections was still rising worldwide. We think greater clarity regarding the trajectory of coronavirus infections and deaths is needed before the economic effects can be more clearly assessed. We will continue to monitor the impact of the pandemic on global supply chains and demand dynamics.

Given the overwhelming policy responses and dramatic actions by the Fed, we think U.S. Treasury yields will remain low across the curve for an extended period. We also believe low oil prices will exert significant disinflationary pressure on the economy.

We plan to take a cautious approach to increasing portfolio risk over the near term. That said, given the compelling valuations resulting from substantially wider yield spreads, we will seek to capitalize on attractive investment opportunities once markets show signs of stabilizing.

Prior to this period, we took steps to reduce risk in the portfolio on the view that volatility was likely to rise and valuations in certain sectors, particularly corporate credit, were becoming increasingly unattractive.

During the past few months, the portfolio’s duration versus the benchmark’s has been neutral to moderately shorter. As of March 31, the fund’s duration was close to the benchmark’s at 5.6 years. The portfolio was positioned to benefit if the yield curve remains relatively steep or steepens further.

Reflecting the fund’s relatively cautious overall positioning, we continue to hold securities across sectors that have less price sensitivity to changes in yield spreads.

Within corporate credit, the fund was modestly underweight investment-grade debt. Our emphasis here continues to be on security selection.

In CMBS, we continue to have exposure to the A- and BBB-rated tranches of CMBX. In our view, hotel and retail properties will be negatively affected by the coronavirus. However, the portfolio’s CMBS exposure is diversified by property type, and we believe CMBX continues to offer the fund a unique investment opportunity.

Within prepayment-sensitive areas of the market, we plan to maintain the fund’s positions in agency IO CMOs and inverse IOs backed by more seasoned loans. We believe this segment of these markets will have less sensitivity to refinancing risk in a low-interest-rate environment.