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The Institutional Class Core Plus Income Fund returned -4.68% in the second quarter, compared to a return of -4.69% for the Bloomberg US Aggregate Bond Index ((Agg.)). Since the beginning of the year, the institutional category of the Fund has posted a return of -8.50% against -10.35% for the index. Negative absolute results are never pleasant to report despite strong relative results. Longer term results (3, 5 and 7 years) continue to outperform the index.

Inflationary pressures remained firm and showed no signs of easing in the second quarter. These pressures precipitated a sharp rise in interest rates as the Federal Reserve announced a 75 basis point interest rate hike for the first time since 1994. On the other hand, investor sentiment shifted, at least temporarily, from concerns about inflation to recession. .

This shift was most visible in the US high yield market, which fell nearly 10% in the second quarter and recorded its worst first half on record in 2022 with a 14.2% decline. The current worst-case yield (YTW) of 8.9% for the Bloomberg US Corporate High Yield Index is the highest since the COVID lockdowns began in March 2020, which peaked at over 11%.

The revision in interest rates and credit spreads, while unpleasant, paved the way for more favorable forward yields. This can be seen in the Fund’s improved YTW metric. As a reminder, YTW has always been a reasonable predictor of futures returns. The Fund’s YTW rose from 3.3% in the first quarter to 5.0% on June 30, 2022, far exceeding Agg’s YTW of 3.7% on June 30.

This is the largest (positive) deviation of YTW for the Fund relative to the index since March 2020. The positive deviation relative to the index is partly attributable to the weighting of around 21 .6% of the Fund in floating rate securities versus no exposure to Agg. The YTW for our floating rate securities incorporates current market expectations for higher short-term interest rates of 3-3.5% by the end of the year.

Portfolio positioning

The chart below shows how we allocated capital to various sectors over the past quarter and year. Since our aim is to invest in sectors that we believe offer the best risk-adjusted returns, our allocations may change significantly over time.

Sector breakdown (% of net assets)

06/30/2022

03/31/2022

Quarter on Quarter Change

06/30/2021

Change from year to year

Corporate bonds

22.2

22.9

-0.7

30.3

-8.1

Corporate convertible bonds

0.5

0.6

-0.1

1.0

-0.5

Asset-backed securities (ABS)

24.0

21.3

+2.7

20.4

+3.6

Corporate Guaranteed Loan Obligations (CLO)*

10.7

10.4

+0.3

7.2

+3.5

Commercial mortgage-backed securities (CMBS)

10.6

10.9

-0.3

10.1

+0.5

Back-to-back mortgage agency (MBS)

1.1

1.2

-0.1

0.3

+0.8

Non-Agency Mortgage Backed (RMBS)

0.5

0.6

-0.1

0.5

0.0

Municipal bonds

0.6

0.6

0.0

0.0

+0.6

Non-convertible preferred shares

0.5

0.7

-0.2

1.1

-0.6

US Treasury

37.5

37.0

+0.5

30.0

+7.5

Ordinary actions

0.0

0.0

0.0

0.0

0.0

Cash and equivalents

2.5

4.2

-1.7

6.3

-3.8

TOTAL

100

100

100

High performance**

12.1

12.9

-0.8

15.0

-2.9

Average effective duration

5.2

4.8

+0.4

4.7

+0.5

Average effective maturity

8.0

7.3

+0.7

6.4

+1.6

*Corporate CLOs are included in the ABS segment in the Fund’s investment schedule, but are additionally referred to separately for discussion purposes. **For the current period, high yield exposure consists of investments in the Corporate, Corporate Convertible, ABS and CMBS sectors.

The only significant change in sector allocation during the quarter was a 2.7% increase in asset-backed securities (ABS). ABS credit spreads have widened significantly, which we believe has significantly improved their relative value against investment grade corporate bonds.

In terms of overall portfolio metrics, the average effective maturity increased to 8.0 years as of June 30, 2022, from 7.3 years as of March 31, 2022, and the average effective duration increased to 5.2 years from 4.8 years over the same period. These measures provide an indication of the Fund’s sensitivity to interest rates. A higher average effective maturity and a longer average effective duration increase the Fund’s price sensitivity to changes in interest rates (up or down). As of June 30, 2022, the average effective duration of the Agg is 6.4 years.

As of June 30, our exposure to high yield as a percentage of net assets was 12.1%, compared to 12.9% as of March 31, 2022. We increasingly view the high yield market as attractive and will seek to grow our exposure in the event of further weakness.

Top Quarterly Contributors

Apart from cash, no segment of the portfolio contributed positively to the Fund’s performance during the second quarter.

Main Quarterly Detractors

U.S. Treasury Bonds: US Treasury holdings were the main drag on performance for the second consecutive quarter. With an effective maturity of around 12 years, our cash portfolio was negatively impacted by the rise in interest rates across the entire curve.

Corporate bonds: Investments in a wide variety of corporate bonds, including high yield bonds, were the second worst detractor to performance during the quarter. The higher yield and longer dated segments of our corporate bond portfolio underperformed the most.

Enterprise CLO: Corporate CLOs detracted from performance as credit spreads widened.

Fund strategy

Our approach is primarily to invest in a diversified portfolio of high quality bonds while maintaining an overall average portfolio duration of 3.5 to 7 years. We may seek to capture attractive coupon income and potential price appreciation by investing in longer duration, lower quality bonds when their price is attractive. We may also invest up to 25% in fixed income securities that are not considered investment grade securities (such as high yield and convertible bonds and preferred and convertible stocks), and we do so when we perceive the risk/return ratio. favorable characteristics.

We do not and will not attempt to emulate any particular index when constructing our portfolio. We believe our flexible mandate and high-conviction portfolio will benefit long-term investors. We use a bottom-up, research-driven approach and select portfolio assets one security at a time based on our view of opportunities in the market. Our fixed income research does not depend on the due diligence work our equity teammates perform on companies and sectors, but often benefits from it.

Overall, we strive to be adequately compensated for the risks assumed in order to maximize the return on investment (or reinvestment) and avoid making bets on interest rates, especially those that depend on the lower interest rates. We have often maintained a lower duration profile than the index, particularly in very low yield environments. Our shorter duration profile has benefited shareholders in times of rising interest rates.

Maintaining a diversified portfolio and cash reserves is a key part of our risk management approach. As a result, we have not been shy about holding US Treasury bonds and, at times like today, large cash reserves. We believe this approach has served our clients well, especially in extreme market environments like the pandemic that hit us in March 2020.

Outlook

Although it is almost certain that the Fed will continue to raise short-term interest rates over the rest of the year, the market has moved accordingly. The forward yields available to investors today haven’t been this attractive since the first and second quarters of 2020. Nominal Treasury bill rates have risen significantly across the curve from a year ago. Credit spreads (the extra yield investors receive over Treasuries) have also increased significantly, particularly in high yield. Please see this quarter’s Fixed Income Insights for more details.

Some additional historical perspective on how long investors (particularly short term) have been starved of yield/yield – since April 2008, the fed funds rate (a key driver of returns for short term investors) has not spent only six months above 2%. The Fed looks set to breach this level (2%) – then some in the second half of 2022. The most common experience for investors during and after the Great Financial Crisis of 2008/2009 was to face and suffer for almost 9 (! ) years of zero interest rate policy (ZIRP). May ZIRP RIP.

Widespread worries/concerns/fears/confusion about the macroeconomic environment (continued inflation, stagflation, possible recession, slowing consumer spending, etc., etc.) often present opportunities for the fundamental investor. We believe now is one of those times – and the Weitz Core Plus Income Fund is well placed, as described above, to take advantage of today’s opportunities and any other valuation mismatch that could develop. While there may still be price drops to come, as the timing is still uncertain, we are seeing greener pastures from today’s levels.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.