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Five Strategies for a Rising-Rate Environment White Paper | September 2015 Not FDIC Insured | May Lose Value | No Bank Guarantee For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public I N V E S T M E N T M A N AG E M E N T Table of Contents Executive Summary Executive Summary 2 ■■ Although recent global market turbulence has complicated the timing, the Federal Reserve has made it clear that it wants to begin raising the federal funds target rate. Introduction 2 Preparing for Rising Rates 3 ■■ Investors are naturally concerned about the U.S. economy’s ability to withstand higher rates and the effects rate tightening may have on their portfolios. A Gradual Upward Course is Likely 3 Long-Term Rate Expectations 4 The Lessons of History 6 Five Strategies for a Rising-Rate Environment7 Conclusion 10 Appendix: Additional Performance Tables 11 ■■ The normalization of policy will likely be different from previous rate-hike cycles, with the Fed employing an extremely measured, gradual process and perhaps fewer hikes than in past cycles. ■■ Even as Fed action gradually pushes short rates higher, long-term rates will likely be capped by the effects of global economic weakness, low inflation and increased demand for fixed income in a low-interest rate world. ■■ If long-term rates remain aligned with GDP growth as they have historically, the ten-year U.S. Treasury rate will likely hover in the range of 2.25–2.75% in the near to intermediate term. ■■ Rising rates typically coincide with a healthy economy in terms of corporate fundamentals, consumer spending and wage growth — a beneficial atmosphere for risk assets. ■■ An investment plan to withstand the coming policy changes should consider: –– Not “bailing out” on bonds, which contrary to conventional wisdom have often performed well when interest rates were rising. –– Adding select credit-oriented assets to offset interest rate risk via potential yield and spread compression. –– Diversifying duration with short-term and unconstrained bonds that are designed to defend against interest rate risks. –– Investing in senior loans to gain from their floating-rate features and tendency to perform better when interest rates rise. –– Capitalizing on economic growth through equity-oriented assets in which economic sensitivity trumps interest rate risk. Introduction Investors have been wrestling with the challenge of how to prepare for the Federal Reserve’s long-awaited change in interest rate policy and the impact higher rates might have on their investments. While market participants seem overly fixated on the timing of the Fed’s first move, the pace and magnitude of the upcoming Fed tightening cycle are the more important considerations. Though history is always an important guide, we expect the next phase of Fed policy normalization to be quite modest compared to previous rate-tightening cycles. Regardless, investors would be well served by having an explicit plan for their portfolios designed to withstand the coming changes in interest rate policy. 2 Five Strategies for a Rising-Rate Environment Preparing for Rising Rates We believe the Fed still wants to initiate its first interest rate hike this year, consistent with its rhetoric for much of 2015. Fed hawks continue to cite the strengthening U.S. economy as justification for a hike, though recent global economic and market volatility could inspire a delay. When the central bank does indeed take action, however, it’s not likely to be driven by runaway inflation or evidence that the slack in the economy has been eliminated. Rather, a Fed move would likely be prompted by concerns about staying accommodative for too long and a desire to return to more “normal” interest rate conditions. We would have to look back to 1999 to find the last (and only) time in which the Fed raised short-term interest rates while core personal consumption expenditure (PCE — its favorite measure of inflation) was near the current level of 1.25%. It’s widely accepted that this 1999 hike had little to do with inflation pressures or an overheating economy; rather, the Fed stepped in to unwind the easing it had introduced in response to the Long Term Capital Management crisis. In that instance, however, the Fed’s good intentions were waylaid by the bursting of the dot-com bubble in March 2000. For this rate-hike cycle, normalization of policy will likely be a slow, measured and well-telegraphed process. For this upcoming rate-hike cycle, the normalization of policy will in all likelihood be a slow, measured and welltelegraphed process. Of course, that doesn’t mean markets will react as expected since market participants must translate economic data and the Fed’s tea leaves into investment decisions. We would expect the curve to flatten over time, consistent with the Fed raising short-term rates in advance of any inflationary pressures that could impact long-term rates. Trajectory of Rate-Hike Cycle Likely to Be Gradual With rates having remained close to zero since December 2008, it understandable that the Fed would want to begin policy normalization. Still, Fed Chief Janet Yellen has been quite clear about the need for patience and moderation given the still-uneven state of this particular U.S. economic recovery and expansion. To this end, the Fed has continually cited concerns over persistent labor market slack, an absence of wage growth and core inflation far below its 2% target rate. The stronger dollar and economic malaise in many parts of the world lend additional support for a patient Fed approach. Annualized Rate (%) Figure 1.Market Expects Less Aggressive Tightening Cycle Than FOMC Projections 3.5 FOMC Median 3.0 Market Rate 2.5 2.0 1.5 1.0 0.5 0 June 2015 June 2016 June 2017 May 2018 Source: Federal Reserve, Bloomberg Data as of June 30, 2015 September 2015 3 While the Fed is on course to begin raising rates, it also has been lowering its projections for the trajectory of this upcoming tightening cycle amid an economy that has yet to truly break out. As can be seen in Figure 1, interest rate markets are factoring in an even lower set of expectations than the Fed itself, with the market currently pricing in the first fed funds hike between late 2015 and early 2016. Interest rate futures also currently imply a fed funds rate expectation of less than 1% by year-end 2016 and well below 2% by year-end 2017. These expectations are a far cry from the average policy rates observed through tightening cycles over the past two decades. Figure 2: The Term Structure of Interest Rates Suggests Gradual Tightening Fed Policy Rate: Spot Rate vs. Implied Rate Annualized Rate (%) 3.0 Projection Spot 2.5 2.0 1.5 1.0 0.5 0.0 June 2015 March 2016 December 2016 September 2017 June 2018 March 2019 December 2019 Source: Federal Reserve, Voya Investment Management Data as of June 30, 2015 Long-Term Rate Expectations Long-term rates may be capped by certain structural and external factors. So, if the market is correctly assuming sub-2% levels for the fed funds rate in the coming years, where does that take the U.S. ten-year Treasury rate? Long-term and short-term rates are highly correlated; thus, if forecasts of a historically low fed funds rate over the next couple of years are realized, the ten-year rate need not rise materially from its current levels. In fact, long-term rates may be capped by certain structural and external factors. The most important external factor serving to dampen long-term rates is the persistent decline of inflationary pressures. The recent collapse in energy prices and the strengthening U.S. dollar will only exacerbate this dynamic as lower prices work their way through the economy. This expectation of lower inflation can be observed best in the U.S. TIPS market, where breakeven rates have fallen steadily. So while real interest rates remain steady, nominal interest rates continue to face downward pressure. One important structural factor keeping long-term rates low is aging global demographics, which increase the likelihood that workers will live longer in retirement. An aging populace is growing more and more evident in retiree pools across Europe and the U.S. This aged cohort should translate into increased demand for fixed income assets as it seeks reliable, low-risk sources of retirement income. Moreover, declining eligibility for and access to defined benefit pension plans likely will intensify individual demand for fixed income assets. 4 Five Strategies for a Rising-Rate Environment One rule of thumb holds that ten-year Treasury rates typically align with long-term U.S. GDP growth. U.S. GDP has grown only at 2.2% on average since the Great Recession; ten-year rates look more or less appropriate given this sluggish rate of growth. So is slower GDP growth transitory or here to stay for a while? Economic growth is a direct byproduct of labor force and productivity growth — two areas in which the U.S. is falling short. U.S. productivity growth of late has recently averaged only 1.1%, the weakest since the 1970s. The aforementioned aging demographics may be a contributing factor. The United Nations predicts the percentage of people 20–64 years of age in the U.S. will grow 0.2% annually over next ten years versus a growth rate of 0.8% over the last decade. As a result, U.S. GDP potential is markedly lower than it has been. So, if the fed funds rate climbs to 2% by 2017, it appears likely that the ten-year Treasury rate could have difficulty rising above 3%, especially in the absence of inflation. We believe this “lower for longer” rate dynamic will be intensified by demand for income in the context of low global interest rates. Given significant quantitative easing by central banks and subdued inflationary pressures, U.S. interest rate markets may be one of the few, if not only, games in town for global investors. As evidenced by Figure 3, there is a tight historical tendency for the Treasury curve to flatten, or even invert, when the Fed embarks on a tightening campaign. This can often mean that long-term rates remain the same or even decline as the Fed begins to raise short-term rates. 3.0 14 2.5 12 2.0 10 1.5 8 1.0 6 0.5 4 0.0 10-year minus 2-year U.S.Treasury Spread (left axis) A flatter yield curve is a natural response to Fed tightening and also reflects the structural headwinds affecting long-term rates. May-15 Jan-13 Mar-14 Nov-11 Jul-09 Sep-10 May-08 Jan-06 Mar-07 Sep-03 Nov-04 Jul-02 May-01 Jan-99 Mar-00 Sep-96 Nov-97 Jul-95 May-94 Jan-92 Mar-93 Nov-90 Jul-88 Sep-89 May-87 0 Jan-85 -1.0 Mar-86 2 Nov-83 -0.5 Annualized Rate (%) Annualized Rate (%) Figure 3. When Short-Term Rates Rise the Yield Curve Tends to Flatten — or Even Invert Fed Funds vs. Curve Steepness Fed Funds Rate (right axis) Source: Bloomberg Data as of May 31, 2015 In sum, we believe policymakers will be cautious and steady in hiking the fed funds rate. Moreover, a pause between hikes likely will be necessary to let the Fed assess the economy’s ability to withstand further tightening, especially in the face of a global economic slowdown punctuated by China’s recent troubles. The labor market has improved consistently, although wage pressures, notably the employment cost index (another Fed favorite), are still weak; as a result, the economy is undershooting the Fed’s inflation target. A flatter yield curve is not only a natural response to Fed tightening but also reflects the structural headwinds faced by long-term U.S. interest rates. September 2015 5 The Lessons of History Despite this moderate interest rate outlook, it is still important to review the potential implications should either the economy or inflation surprise to the upside and encourage more aggressive action from the Fed. History here serves as a good guide and allows us to examine the behavior of various asset classes during prior Fed tightening campaigns, as illustrated in Figures 4 and 5. Figure 4. Characteristics of Historical Fed Tightening Periods Fed Funds Rate Before (%) After (%) Increase (%) Length (year) Pace (%/year) 04/1987–02/1989 5.88 9.75 3.87 1.92 2.02 Period 02/1994–02/1995 3.00 6.00 3.00 1.07 2.79 06/1999–05/2000 4.75 6.50 1.75 1.00 1.75 06/2004–06/2006 1.00 5.25 4.25 2.08 2.04 Average 3.22 1.52 2.15 Source: Barclays Figure 5. Plenty of Positive Performance During Past Fed Tightening Periods Returns by Asset Class (%) Period 04/1987–02/1989 Intermediate Bonds High Yield Bonds Short-Term Bonds GNMA Bonds Large-Cap Equity Senior Loans 5.01 6.35 6.01 6.16 3.00 N/A 02/1994–02/1995 0.01 1.43 2.48 2.19 4.10 9.54 06/1999–05/2000 2.11 -3.21 4.02 3.20 10.48 3.93 06/2004–06/2006 3.09 8.20 2.01 3.47 8.16 5.88 Average 2.55 3.19 3.63 3.76 6.43 6.45 Source: Barclays, Morningstar, Voya Investment Management Note: Asset class performance is represented by the following indexes: Barclays U.S. Aggregate Bond Index, Barclays U.S. Corporate High Yield Index, Barclays U.S. Government/ Credit 1–3 Year Bond Index, Credit Suisse Leveraged Loan Index, Standard & Poor’s 500 Stock Index, Barclays GNMA Index. Past Performance does not guarantee future results. Performance shown is historical and not indicative of any specific product and does not account for fees and expenses associated with investing in funds. Investors cannot directly invest in an index. 6 Five Strategies for a Rising-Rate Environment Five Strategies for a Rising-Rate Environment Given the Fed’s well-telegraphed intentions to raise short-term interest rates, many investors are concerned about how their portfolios may be impacted by a tightening cycle. What are the best ways to avoid interest rate risk and protect portfolios in a rising-rate environment? Below we present five ideas. ■■ Don’t “bail out” on bonds. Intermediate bonds have done surprisingly well in rising-rate periods, and astute active management can manage interest rate risk and access multiple sources of excess returns to produce better-than-index results. Accordingly, investors should not prematurely bail out on bond funds simply because rates are likely to rise. Moreover, since we expect only a gradual rise in rates accompanied by a flat yield curve and low longer-term rates, we would expect intermediate bond funds to weather the next Fed tightening cycle quite well compared to the more aggressive rising-rate periods of the past. Actively managed agency mortgage funds may also be well suited to a defensive interest rate posture provided the manager has demonstrated the ability to conserve capital in a duration-sensitive sector. Many have been quick to draw parallels between today’s climate and previous tightening episodes, and the performance of bonds during these periods demonstrates surprising stability. Broadly diversified intermediate bonds (based on the Barclays U.S. Aggregate Bond Index) did not lose money in any of the four historical tightening periods, and average total return was 2.55% over an 18-month rate-hike cycle. Apparently, diversification was able to overcome the rate sensitivity of the U.S. Treasuries. Since returns in rising-rate periods have never been negative, concerns about capital preservation would likely have been satisfied by staying with fixed income through such events. We would expect intermediate bond funds to weather the next Fed tightening cycle quite well. ■■ Add credit risk. Rising rates usually accompany a strong economy in which economic sensitivity and credit risk are rewarded. Credit-oriented assets such as high yield bonds or securitized credit (asset-backed securities, commercial mortgage-backed securities and non-agency residential mortgage-backed securities) are recognized ways to reduce interest rate exposure in favor of credit risk exposure. Investors should be aware that adding credit risk with high yield bonds may bring higher correlation to equity markets, which could amplify equity-market related volatility. Securitized credit offers credit exposure but replaces equity-like characteristics with exposure to mortgage markets. Below-investment-grade bonds can play a surprisingly helpful role in a portfolio during a period of rising rates, providing high income and the benefits of economic expansion — a double-barreled defense against interest rate risk. This is no guarantee that funds with high yield exposure will outperform as the Fed begins to remove monetary accommodation. However, during every aforementioned tightening period except the June 1999–May 2000 episode, the Barclays U.S. High Yield Index outperformed the U.S. Aggregate Bond Index. Combining all four past tightening periods, the high yield index provided an average return of 3.19% compared to 2.55% for the Barclays U.S. Aggregate Bond Index. History has also shown us that capital gains are typical for high yield bonds, as spreads often tighten shortly after the Fed begins to raise rates. With high yield spreads currently much wider than historical averages, this asset class may offer an opportunity for spread compression and outperform more duration-sensitive sectors such as investment grade corporates and U.S. Treasury bonds. The conditions that tend to lead to rate hikes — solid economic growth and higher inflation — appear to support the argument for high yield bonds as a permanent part of most portfolios regardless of the timing of Fed policy changes. Notwithstanding today’s benign credit risk environment, those who are interested in belowinvestment-grade bonds need to seek out managers with strong security-selection capabilities to avoid defaults — which will eventually rise — and stay focused on the “right” credit risks. September 2015 7 ■■ Diversify duration. Given their lower interest rate sensitivity, short-term bonds tend to offer modest but highly dependable returns in most market conditions, giving them the best return-to-risk ratio of the assets in our analysis. Suitable unconstrained bond funds have wide flexibility to maintain an appropriate balance of credit and duration risks in order to weather periods of uncertainty with low correlation to volatile equity markets. Some unconstrained managers may avoid interest rate risk and instead over-allocate to credit risk, which can increase correlation with equities. A better approach would involve actively managing sector, credit and duration risks in order to deliver a balanced, resilient strategy as market conditions change over time. Our research indicates that most investors are woefully under-allocated to senior loans Our table of past performance shows that a representative index of one- to three-year investment-grade bonds performed well in each of the past four Fed rate-hike occurrences. This record was achieved notwithstanding the fact that yields on short-term bonds tend to rise more than that of longer-term issues because they are more closely aligned with the rising fed funds rate. For a given change in rates, the price on long-dated bonds will decline more than the price on short-term bonds. So the short maturities provide a defense against the effects of rising rates, and high grade corporate debt enhances income without throwing caution to the wind. On average, including both rising- and stable-rate periods since 1986, short-term bonds have the highest return-to-risk ratio of any investment in our analysis. Both unconstrained and short-term bond funds should deliver the benefit of lower interest rate sensitivity, and each has the potential to earn higher yields as policy rates rise. ■■ Invest in Senior Loans. The floating rate interest paid on a senior loan may rise and fall with changes in interest rates, but a change in rates alone rarely impacts the price of that loan. Absent other factors such as changes in the creditworthiness of a borrower, the price of a senior loan is generally unaffected by changes in market interest rates. Of course, prices may fluctuate for other reasons, but in a broadly diversified loan portfolio such changes have been moderate, except in the event of economic catastrophe (such as in 2008). Loans pay a two-part coupon — a market interest rate (typically 60-day LIBOR) plus a contractual yield spread. In the current low-interest rate environment, most loans are issued with a LIBOR floor — thus, a minimum rate (today averaging about 1%) on the market interest rate part of the coupon. As of June 30, 2015, about 92% of the loans in the S&P/LSTA Leveraged Loan Index have a LIBOR floor. On the same date, the 60-day LIBOR rate was 23 basis points (bps), which makes the gap between actual LIBOR and the LIBOR floor 77 bps. Thus, when rates begin to rise, the loan income for such loans will not increase until LIBOR rates climb above the applicable floor. From then on, the coupon of the loan will once again begin to float. However, until rates rise investors still enjoy a yield “subsidy” provided by the floor, effectively earning an additional 77 bps of yield. With still-great uncertainty around when and how rates will actually rise, it seems prudent for investors to buy senior loans now and enjoy the current yield subsidy while preparing for the longer-term extended rise in rates. Our research indicates that most investors are woefully under-allocated to senior loans — on average, the investments account for only 1–2% of retail portfolios — and many investors may be unaware of their investment advantages beyond realizing that floating rates are a good idea when interest rates rise. It’s the only asset in our study that performs best when rates are rising. But today’s strong corporate fundamentals also favor loans. And they offer unique diversification benefits; with their low correlation to fixed-coupon bonds in general, senior loans are a natural counterpoint to all fixed income investments. 8 Five Strategies for a Rising-Rate Environment Loans are especially effective in a 50%/50% combination with high yield bonds because their virtually zero duration cuts the combined interest rate risk in half while their historically higher recovery rates in the event of default cut potential credit losses in half. We favor a permanent allocation to loans — in the neighborhood of at least 10% of a portfolio — and for those who have yet to invest, today’s economic and market conditions present a potentially ideal entry point. Careful consideration is in order when selecting a senior loan fund. Not all are created equal. Some invest purely in loans; others dabble in high yield bonds, convertibles or other assets. If the investor wants all the advantages of loans in a rising-rate environment, a “pure play” fund is best. Similarly, keep in mind that senior loans are below investment grade: broad diversification and in-depth fundamental research aimed at avoiding defaults (and actual credit losses) are crucial steps in keeping their potentially high income stable and reliable. Senior loans have stood out, with virtually no interest rate risk and an excellent record in rising rate conditions. The three-cycle average performance of 6.45% of senior loans (as measured by the Credit Suisse Leveraged Loan Index) compares favorably to all the other assets in our performance table. While past performance is no guarantee that bank loans will perform in a similar manner in the coming rate-hike cycle, senior loans offer a unique natural hedge against rising rates and remain a preferred asset class for interest rate risk protection. And senior loans are economically sensitive. If the U.S. economy continues to grow at a reasonable rate, it’s probable that loans will deliver attractive returns relative to other assets regardless of when or at what speed the Fed decides to increase short-term rates. ■■ Capitalize on growth. When economic growth is improving, investors amenable to greater equity exposure should consider the potential of stocks in general and REITs in particular. Given their economic sensitivity, both asset classes have historically performed well in rising-rate conditions (though not without volatility) and could be suitable depending on an investor’s risk tolerance. In terms of REITs, healthy economic growth means improving real estate fundamentals, such as rents and occupancy. Given markedly improved employment conditions, residential real estate prices have rebounded and the commercial real estate market is healthy. If the economy continues to expand at a moderate pace, the outlook for mortgage-backed bonds and REITs should also be positive — even if a transition to normalized short-term rates may induce some bumps along the road. September 2015 9 Conclusion Given expectations for rising interest rates and investors’ justifiable desire to protect their portfolios against losses, we considered five investment strategies encompassing six asset classes that historically have performed well in rising-rate conditions. As you can see in Figure 6, senior loans have stood out, with virtually no interest rate risk and an excellent performance record in rising-rate conditions. Figure 6. The Performance of Senior Loans During Rising-Rate Periods Has Stood Out Risk/Return Ratios of Selected Asset Classes in Rising-Rate Periods 7.0 Senior Loans U.S. Large-Cap Equities 6.0 Return % 5.0 4.0 Agency Mortgages Short Duration Bonds 3.0 High Yield Bonds Intermediate Bonds 2.0 1.0 0.0 0.0 4.0 8.0 12.0 16.0 Standard Deviation % Source: Barclays, Morningstar, Voya Investment Management Data as of June 30, 2015. Note: Asset class performance is represented by the following indexes: Barclays U.S. Aggregate Bond Index, Barclays U.S. Corporate High Yield Index, Barclays U.S. Government/ Credit 1–3 Year Bond Index, Credit Suisse Leveraged Loan Index, Standard & Poor’s 500 Stock Index, Barclays GNMA Index. Past Performance does not guarantee future results. Performance shown is historical and not indicative of any specific product and does not account for fees and expenses associated with investing in funds. Investors cannot directly invest in an index. 10 Five Strategies for a Rising-Rate Environment Appendix: Additional Performance Tables Total Returns During Stable-Rate Periods Intermediate Bonds High Yield Bonds Short-Term Bonds GNMA Bonds Large-Cap Equity Senior Loans 09/1986–03/1987 3.92 10.26 3.05 6.11 17.52 N/A 08/1989–06/1990 5.61 -1.32 6.86 7.43 6.84 N/A 10/1992–01/1994 8.53 15.24 4.79 6.28 14.33 10.44 02/1996–02/1997 3.24 11.32 4.62 5.52 24.99 7.70 04/1997–08/1998 11.53 7.46 7.62 10.08 19.95 7.58 12/1998–05/1999 -0.76 2.53 1.35 1.39 12.61 3.48 06/2000–12/2000 9.58 -2.76 6.14 8.69 -6.47 3.17 01/2002–10/2002 8.05 -8.44 5.14 7.52 -21.84 -2.13 12/2002–05/2003 6.29 16.78 2.96 2.09 3.87 6.69 07/2003–05/2004 -0.24 8.77 0.74 1.22 16.84 6.79 07/2006–08/2007 7.09 7.72 5.99 6.98 15.75 3.61 01/2009–06/2015 4.31 15.13 1.78 4.00 16.01 11.07 Average 5.60 6.89 4.25 5.61 10.03 5.84 Senior Loans Period Source: Barclays, Morningstar, Voya Investment Management Data as of June 30, 2015 Total Returns During Falling-Rate Periods Period Intermediate Bonds Short-Term Bonds GNMA Bonds Large-Cap Equity 01/1986–03/1987 13.51 High Yield Bonds 20.12 9.34 11.86 33.87 N/A 06/1989–01/1994 11.07 13.18 8.67 10.72 12.60 N/A 07/1995–02/1997 6.33 12.21 5.98 7.44 27.89 7.49 09/1998–05/1999 1.60 5.07 3.13 3.08 37.42 2.86 01/2001–05/2004 6.49 8.89 5.19 5.66 -3.15 4.98 09/2007–06/2015 4.74 8.31 2.48 4.83 6.68 4.67 Average 7.29 9.28 5.80 7.27 19.22 5.00 Source: Barclays, Morningstar, Voya Investment Management Data as of June 30, 2015 20-Year Return-to-Risk Ratios for Periods Ended June 30, 2015 Asset Class Return-to-Risk Ratio Intermediate Bonds High Yield Bonds Short-Term Bonds GNMA Bonds Large-Cap Equity Senior Loans 1.61 0.83 2.80 2.15 0.59 0.94 Source: Barclays, FactSet, Voya Investment Management Note: Asset class performance is represented by the following indexes: Barclays U.S. Aggregate Bond Index, Barclays U.S. Corporate High Yield Index, Barclays U.S. Government/ Credit 1–3 Year Bond Index, Credit Suisse Leveraged Loan Index, Standard & Poor’s 500 Stock Index, Barclays GNMA Bond Index. Past Performance does not guarantee future results. Performance shown is historical and not indicative of any specific product and does not account for fees and expenses associated with investing in funds. Investors cannot directly invest in an index. September 2015 11 Investment Risks Past Performance does not guarantee future results. Performance shown is historical and not indicative of any specific product and does not account for fees and expenses associated with investing in funds. Investors cannot directly invest in an index. There are no guarantees a diversified portfolio will outperform a non-diversified portfolio. All investments in bonds are subject to market risks. Bonds have fixed principal and return if held to maturity, but may fluctuate in the interim. Generally, when interest rates rise, bond prices fall. Bonds with longer maturities tend to be more sensitive to changes in interest rates. All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. High Yield Securities, or “junk bonds”, are rated lower than investment-grade bonds because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities. As Interest Rates rise, bond prices may fall, reducing the value of the share price. Debt Securities with longer durations tend to be more sensitive to interest rate changes. High-yield bonds may be subject to more Liquidity Risk than, for example, investment-grade bonds. This may mean that investors seeking to sell their bonds will not receive a price that reflects the true value of the bonds (based on the bond’s interest rate and creditworthiness of the company). High Yield Bonds are also subject to Economic Risk which describes the vulnerability of a bond to changes in the economy. Senior Loan Risks: Below investment grade loans involve a greater risk that borrowers may not make timely payment of interest and principal on their loans. They also involve a greater risk that the value of such loans could decline significantly. If borrowers do not make timely payments of the interest due on their loans, the yield on a portfolio invested will decrease. If borrowers do not make timely payment of the principal due on their loans, or if the value of such loans decreases, the value of a portfolio invested will decrease. Demand for loans: An increase in demand for loans may adversely affect the rate of interest payable on new loans acquired by a portfolio invested, and it may also increase the price of loans in the secondary market. A decrease in the demand for loans may adversely affect the price of loans in a portfolio invested, which could cause such portfolio’s value to decline. All equity investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. Foreign Investing does pose special risks including currency fluctuation, economic and political risks not found in investments that are solely domestic. Emerging Market stocks may be especially volatile. Stock of an issuer in the Fund’s portfolio may decline in price if the issuer fails to make anticipated Dividend Payments because, among other reasons, the issuer of the security experiences a decline in its financial condition. Securities of Small- and Mid-Sized Companies may entail greater price volatility and less liquidity than investing in stocks of larger companies. General Real Estate Risks: Property values may fall due to increasing vacancies or declining rents resulting from economic, legal, cultural or technological developments. The price of Real Estate Equity Securities may drop because of falling property values, increased interest rates, poor management of the company or other factors. Many companies utilize leverage, which increases investment risk and could adversely affect a securities’ operations and market value in periods of rising interest rates. Important Information This paper has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors. The opinions, views and information expressed in this presentation regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Portfolio holdings are fluid and are subject to daily change based on market conditions and other factors. Products and services are offered through Voya family of companies. Please visit us at http://voya.com for information regarding other products and services offered through Voya family of companies. Not all products are available in all states. Voya Investment Management Co. LLC (“Voya”) is exempt from the requirement to hold an Australian financial services license under the Corporations Act 2001 (Cth) (“Act”) in respect of the financial services it provides in Australia. Voya is regulated by the SEC under U.S. laws, which differ from Australian laws. 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