Martin Sheen played President Jed Bartlet on the NBC TV show The West Wing in the early 2000s. Often, after wrapping up some stressful or momentous piece of the story, he would say, “What’s next?” We find ourselves as investors constantly asking the same thing. After all, markets are forward looking, and so should we be. A common investing mistake can come from looking backwards and assuming the recent past is a good predictor of what will come. The constant drumbeat in our minds is “What’s next?” and most times, that’s enough to spur meaningful insights on what is to come.

As we embark on 2023, the common worries that pervade the market at the end of 2022 are well established: 1) Are we headed for a recession? (If so, it will be the most highly anticipated recession of our careers), 2) Will inflation get under control, and will the Federal Reserve have to raise rates meaningfully beyond what the market expects? The answers, as always, are never clear until they are retrospective. Perhaps, this one time, the best way to figure out how these two questions resolve themselves in 2023 might be to look back at 2022. Rather than assuming last year will continue, it seems likely this year will have to be very different. One year ago, the Federal Funds rate was at 0%, and the market predicted fewer than four 25 basis point increases throughout the year. That’s right, it’s easy to forget, but the market was predicting Federal Funds of 0.9% at the end of the December Federal Reserve meeting. Instead, the market got a Federal Funds rate of 3.5% higher! Even more importantly, the generic 10-year US Treasury yielded merely 1.75% in January but over 3.75% at the end of the year. This led to the Barclays Aggregate Index falling over 11% during the year, high yield bonds lost over 11%, and investment grade corporate bonds lost over 15%.

As a bond investor, what are the most significant realistic risks this year? The questions above point to the two ever-present risks associated with owning a bond – credit risk and duration risk. If the answer to question 1 above is ‘yes, we are headed for a recession’, then credit risk could be a key driver of negative returns for bonds, but especially for lower quality bonds. In the event of a recession, spreads could move wider by at least 200 basis points for high yield bonds from around 450, where they closed in 2022. In a sell-off induced by a bad recession, high yield spreads typically approach or exceed 1,000 basis points. That doesn’t seem likely at present, but it rarely does. In the same sort of downturn, we would anticipate investment grade bond spreads to stay anchored closer to existing levels. As such, our current bias remains in higher quality names until we are more convinced that no recession is imminent.

Question 2 above has recently gotten the most attention because the market got the answer so terribly wrong for much of 2022. What would it mean to be wrong on rates this year? Last year it meant missing the Federal Funds rate by 350 basis points and the 10-year Treasury yield by over 200 basis points. That magnitude of error seems highly unlikely this year, given that inflation appears to have peaked, and the question now centres more on where the inflation rate settles once it has finished cooling off. The highest estimate we have heard for the terminal Fed Funds rate seems to be 6%, but that’s only 100 basis points higher than the market has currently priced. Said another way, the downside to owning bonds is dramatically smaller now than it was a year ago. Intuitively, the upside to owning them is also much better than it was a year ago – both because yields are much higher and because there’s a real chance that economic conditions force rates lower.

Last year, we became wary first of duration risk and then of credit risk relatively early in the year. As such, the Credit Income fund outperformed (beat the U.S. Aggregate Bond Index by over 4.5%, beat the ICE BAML BB-B Global High Yield Constrained Index by over 4.5%, beat the U.S. Investment Grade Index by nearly 7%). As central banks lift short rates, our fear of duration will wane. We are still cognizant that credit spreads could pose a material risk, so, for the time being, our positioning will probably be on the side of higher in the ratings scale. As
ever, we will be vigilant in our search for data points that disprove this fear, or information that contests are growing comfort with duration. In the meantime, we will continue our never-ending search for idiosyncratic single-name opportunities while wondering “What’s next?”

Sources for all data: JOHCM/Bloomberg (unless otherwise stated).

The performance data quoted represents past performance; past performance 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. The Fund's current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days at www.johcm.com or by calling 866-260-9549 or 312-557-5913.

Returns shown, unless otherwise indicated, are total returns, with dividends and income reinvested. Returns for periods of less than one year are not annualized. Fee waivers are in effect; if they had not been in effect performance would have been lower.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. Any Indicies mentioned are unmanaged statistical composites of stock market performance. Investing in an index is not possible.

Historical performance of the International Select Fund for Class II Shares prior to its inception is based on the performance of Class I Shares. The performance of Class II Shares has been adjusted to reflect differences in expenses.

*Expense ratios as stated in the latest prospectus. JOHCM (USA) Inc. has contractually agreed to waive fees and reimburse expenses so that the Net Total Operating Expenses do not exceed the stated amounts until January 28, 2024.

The performance data quoted represents past performance; past performance 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. The Fund's current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days at www.johcm.com or by calling 866-260-9549 or 312-557-5913.

Returns shown, unless otherwise indicated, are total returns, with dividends and income reinvested. Returns for periods of less than one year are not annualized. Fee waivers are in effect; if they had not been in effect performance would have been lower.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. Any Indicies mentioned are unmanaged statistical composites of stock market performance. Investing in an index is not possible.

Historical performance of the International Select Fund for Class II Shares prior to its inception is based on the performance of Class I Shares. The performance of Class II Shares has been adjusted to reflect differences in expenses.

*Expense ratios as stated in the latest prospectus. JOHCM (USA) Inc. has contractually agreed to waive fees and reimburse expenses so that the Net Total Operating Expenses do not exceed the stated amounts until January 28, 2024.