Question: Michael, U.S. high-yield bond markets struggled in 2015 and to start 2016, but they have bounced back, what’s your take on the sector?

Answer: High-yield bonds have had a nice run since the global financial crisis. We’ve had seven years of economic expansion, so as the cycle has aged, it’s not surprising to see returns revert some. We also had oil prices fall to 13-year lows in February, spooking a lot of investors given the significance of the energy sector in the BofA Merrill Lynch U.S. High Yield Constrained Index (the Index) and the prospect that those energy companies may start to default at higher rates, which has actually come to fruition. In U.S. dollar terms, the Index was down over 4.5% in 2015 and another 5% plus just in early 2016, so down almost 10% in total. We believe that was probably a little bit of an overreaction and that assertion has been justified by a pretty sharp rebound, about 11%, over the past two months or so. Oil prices have come back too –and that’s a positive development for the energy sector.

Q: You mentioned increased defaults in the energy sector. If defaults are increasing why wasn’t the decline justified?

A: Defaults are part of investing in the asset class, that’s why investors demand more yield to compensate for the higher default risk. Have we seen defaults increase, especially in the energy sector? Yes. Are we going to see more defaults there? Yes, we believe so, but we’re still not overly concerned. Defaults are rising and currently stand just below the historical average. Default rates are measured using trailing 12-month periods. Since 1980 the average default rate is 4.39%; we were at 4.09% as of March 31, 2016. The Moody’s baseline forecasts for U.S. Speculative Grade Defaults are 6.11% for January 2017 but falling to 5.65% by March 2017. A lot of investors hear the word “default” and just assume a company that defaults on its bonds is going bankrupt, out of business. Sure, that happens sometimes, but not all defaults result in that scenario. It’s pretty rare for a company to default overnight, a lot of the bonds that are at the highest risk for default are already trading well off of face value, so a considerable amount of the default risk has usually already been priced in.

Q: So your outlook is relatively positive for U.S. high-yield bonds?

A: We viewed the market as very attractive when the index had a yield to worst 10.10% on February 11. At its current yield to worst of 7.71% (as of 4/21/16) some of the value has been taken out, but yes, overall we’re still relatively positive on high-yield. A coupon-like return for the rest of 2016 seems possible assuming oil prices do not re-test recent lows. The current rally has been swift so a pullback on overbought conditions should not be ruled out, which obviously would dampen performance. We believe defaults are an incremental negative, although not enough to sour us on the asset class. The yield spread over investment-grade, both corporates and Treasurys, is still attractive.

Q: How are you positioned?

A: We’ve been slightly defensive for a while now, which we believe is prudent especially given the expected rise in defaults. Tight liquidity in high-yield bonds means you can’t just wake up one day and decide you want to go defensive; it takes time to properly build a position. Part of the defensive posture is a position in bank loans. We generally expect loans to perform better than bonds in a rising interest rate environment, and they rank higher than bonds in the capital structure. We’re also holding moderately higher cash than normal. This probably doesn’t come as a surprise, but we are underweight the energy sector as well as the metals/mining excluding steel group, which is a subsector of basic industry. Conversely, we’re overweight leisure, primarily gaming, and media. While the gaming sector is not a large index component, we have conviction that some credits are undervalued and offer strong total return potential. As for media, it is an asset-rich sector with strong cash flow generation and reasonable amounts of leverage. Both sectors are generally less sensitive to changes in macroeconomic conditions.

Q: What events should result in the most upside for U.S. high-yield bonds?

A: We’ve briefly touched on the macroeconomic outlook and oil prices; we think improved growth and oil prices stabilizing at higher levels would be positive. At the security level our managers are always looking for companies that could get upgraded, which typically results in outsized gains. If none of these positive events come to pass, there is always the option to sit back and “clip coupons”.

Q: What about the biggest risks?

A: In addition to the typical risks of investing in high-yield bonds, we have some macroeconomic concerns. If better growth and higher oil prices are positive, we think it stands to reason that slower growth and oil prices retracing their recent gains are negative. Still, we don’t believe these are disastrous risks unless there is a full-blown recession, which we do not expect.

Fund Risks

• A decline in the credit quality, or perceived credit quality, of an issuer could cause the value of investments held by the Fund to decline. Also, the issuer of an investment held by the Fund may not meet its payment obligations.
• Increases in interest rates are likely to cause the value of bonds or similar assets held by the Fund to decline in value.
• Certain securities may be or may become difficult or impossible to sell. In certain circumstances, the Fund may be forced to sell such securities at substantially lower prices, or may be required to sell other securities that the Fund otherwise would not have wished to sell.
• Low rated or unrated securities can be more volatile, less liquid and more sensitive to market and credit risk than higher rated securities and may be more susceptible to large price declines and difficulty in valuation or sale.
• For further details of the risks, please refer to the Fund's prospectus.

Glossary

Defensive: Defensive positioning is less sensitive to movements in the broad market and therefore tends to have more stable performance.

Liquidity: Liquidity refers to the ease at which a holding can be bought or sold.

Macroeconomic: Macroeconomic refers to the broad economy of a country or region, or the global economy.

High-yield bonds: High-yield bonds are rated below investment grade and are considered to be riskier.

Leverage: Leverage refers to the degree to which an investor or company is using borrowed money to finance activities. For example, a highly leveraged company would have a significant amount of debt relative to its equity. Leverage can help increase returns, but can also increase risk in that it may be more difficult to make payments on debt.

Yield to worst: Yield to worst is the lowest potential yield that can be received on a bond without the issuer defaulting.

Yield spreads: Yield spreads represent the difference in yields offered between different types of bonds. If they tighten, this means that the difference has decreased. If they widen, this means the difference has increased.

Index Definitions

BofA Merrill Lynch U.S. High Yield Constrained Index: The BofA Merrill Lynch U.S. High Yield Constrained Index contains all securities in The BofA Merrill Lynch U.S. High Yield Index but caps exposure to individual issuers at 2%. The BofA Merrill Lynch U.S. High Yield Index tracks the performance of below-investment grade, U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.

Past performance is not a guarantee of future performance.

Investments in SEI Funds are generally medium to long term investments. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. Additionally, this investment may not be suitable for everyone. If you should have any doubt whether it is suitable for you, you should obtain expert advice.

No offer of any security is made hereby. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application may be made solely on the basis of the information contained in the Prospectus. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Bonds and bond funds are subject to interest rate risk and will decline in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. Narrowly focused investments and smaller companies typically exhibit higher volatility. SEI Funds may use derivative instruments such as futures, forwards, options, swaps, contracts for differences, credit derivatives, caps, floors and currency forward contracts. These instruments may be used for hedging purposes and/or investment purposes.

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