Liontrust GF Strategic Bond Fund

The Liontrust GF Strategic Bond Fund returned -0.3% in US dollar terms in January. The average return from the EAA Fund Global Flexible Bond (Morningstar) sector, the Fund’s reference sector, was -0.1%.

The thin blue line

January was a month of both alarming and bizarre events for financial markets. The attempted coup in the US certainly falls into the alarming camp, fortunately America’s electoral processes and institutions held fast; democracy prevailed in the end. On the bizarre front: hedge fund short sellers experienced some heavy losses at the hands of the Reddit “wallstreetbets” crowd. The market distortions seen in GameStop’s share price are not a sign of a well-functioning market but the reminder to those caught out should be to avoid crowded positions and have a strong stop-loss discipline. These salutary lessons are applicable across all financial markets.

But enough of a digression, the most important event for the markets in January was the Democrat’s eventual clean sweep of the election. Against strong odds, the Democrats won both of the runoff senate seats in Georgia. With the Senate now split 50/50, Vice President Harris has the casting vote; thus, the Democrats will have a slim majority in both chambers as well as the presidency. Budgets can be passed under the 50+1 majority and there is executive privilege; for example, the US is already re-joining the Paris Agreement on climate change. However, for more ground-breaking domestic policy there is a 60/40 Senate hurdle to overcome due to the cloture rule (Rule 22); this effectively allows for the filibustering of any legislation unless 60 Senators agree to halt debate. Perhaps, therefore, it is not a surprise that President Biden is currently attempting bipartisan efforts to pass the stimulus bill.

Even if the US$1.9 trillion proposed stimulus gets watered down, one should still anticipate a significant fiscal boost in the next few months. The majority of tax rises are likely to be delayed until the economic recovery has gained significant traction. New US Treasury Secretary Yellen is likely to work more closely with the Federal Reserve under a co-ordinated recovery program; obviously Powell worked with Yellen when she was chair of the central bank.

Sovereign bond markets are priced for a continuation of emergency monetary policy. There will be huge tensions this year with the bond market testing the Fed’s resolve to keep policy loose. We continue to believe there will be a mini taper tantrum, not because tapering itself will occur but simply due to the market fear of any form of reduction in the easy money drug that it has become addicted to.

Rates

The Fund continues to run with a low beta duration strategy. For the majority of January the duration was 2.75 years^† but after the rise in yields on the last day of the month a small increase back to 3 years was made. As a reminder, duration exposure of 3 years is below our neutral of 4.5 years and way below the index level of 7.5 years. Furthermore, we are likely to continue to oscillate in a 2.5 to 3-year range until such time as the US 2s10s yield curve reaches 125 basis points; if we do reach this level we would reduce the size of the duration underweight as Powell’s Fed would likely start to consider some intervention.

Beneath the headline duration we continue to be active in targeting alpha within Rates. We have reduced the size of our European 5s10s flattener (being long 10-year debt relative to 5-year debt) by half a year and would now oppose any big market move in either direction.

Looking at cross-market valuation opportunities, two new trades were implemented during January. Firstly, the Fund is short Canadian debt relative to Australia. Both economies are broadly dollar bloc in nature and are exposed to any commodity upswing, thus global fundamentals for both countries should exhibit a strong correlation; we expect the valuation gap to close over time regardless of market direction.

A similar valuation mismatch has arisen in two high quality AAA rated European sovereign issuers; the Fund is long 10-year Swedish government debt relative to Germany. We like this position as not only is there a valuation mismatch, it is also “carry” positive even after currency hedging implicit costs, and the Swedish curve is very steep around the 10-year tenor. The last point means that as time progresses one should naturally see Swedish outperformance as the bond’s maturity decreases.

Allocation

The Fund’s investment grade weighting is at 47.5%, just below our 50% neutral position. We have a preference for high quality high yield, where we see a better valuation opportunity. The Fund’s weighting in high yield was increased to 27.5% during the period, which saw slightly higher volatility toward the end of the month. This is split between just over 23% in physical holdings and a net 4.3% long in high yield CDS indices. The Fund retains its cross-market position, preferring the European iTraxx Xover CDS Index to the riskier US HY CDX equivalent.

Selection

With a large amount of primary issuance to choose from, we can afford to be very selective about deploying the Fund’s cash. One attractive new opportunity in January was a Zurich Insurance bond denominated in dollars, which was issued as part of its financing for the takeover of Metlife’s P&C arm. One lesser known name we bought bonds in was CAF (Corporacion Andina de Fomento), a Latin American development bank. A combination of preferred creditor status and strong capitalisation make this a very high quality investment, which the ratings agencies recognised in assigning high single A/low double A ratings. Yet 5-year bond spreads are still over 100bps, making this is a great cheap buy-and-hold investment for the Fund.

On the selling front, we exited AT&T exposure ahead of large anticipated issuance as the company will need to fund the spectrum they are acquiring in the US C-Band auction. This should create a cheap re-entry point. Exposure to the US gaming property company GLPI was also sold based on the bonds having become fully valued.

New high yield positions were purchased in the secondary market. Firstly Eircom, the Irish telecommunications company, which fits our theme of high quality high yield yet still with a credit spread over 300bps. Secondly, we bought bonds in Grifols, the Spanish blood plasma company; the spread here is less generous at 250bps but this reflects the defensiveness of the company and a US$14 billion market capitalisation sitting as a cushion below bondholders.

Discrete 12 month performance to last quarter end (%)**:

*Source Financial Express, as at 31.01.21, total return, B5 share class.

**Source Financial Express, as at 31.12.20, total return, B5 share class. Discrete data is not available for five full 12 month periods due to the launch date of the portfolio.

Fund positioning data sources: UBS Delta, Liontrust.

^†Adjusted underlying duration is based on the correlation of the instruments as opposed to just the mathematical weighted average of cash flows. High yield companies' bonds exhibit less duration sensitivity as the credit risk has a bigger proportion of the total yield; the lower the credit quality, the less rate-sensitive the bond. Additionally, some subordinated financials also have low duration correlations and the bonds trade on a cash price rather than spread. 

KEY RISKS

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.

DISCLAIMER

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.