Liontrust Strategic Bond Fund

The Liontrust Strategic Bond Fund returned -0.7%* in sterling terms in February. The average return from the IA Sterling Strategic Bond sector, the Fund’s comparator benchmark, was -1.0%.

Bond investors have had a great decade. Central bank manipulation, QE, NIRP and the like took bond prices to astronomical levels. This put value driven, active managers in a cleft stick – trade markets expecting further support and price rises or seek alternative ways to add value without risking it all. Admittedly, it is a general comment but we’ve adopted the latter approach pretty much since Mario Draghi’s “whatever it takes” speech.

Since 2010, there have been a few false dawns for the bond bear market. Generally, those owed more to central bank actions than those of the market – perhaps the most obvious and oft quoted was Ben Bernanke’s “taper tantrum”. February was a little different, markets and investors leading, central bankers reluctant to follow.

By the end of the month, the Bank of America Gilt Index had fallen 7.5% year-to-date, putting losses for the Strategic Bond sector into perspective perhaps. Investors had shunned bonds for most of 2021, the word on everyone’s lips being “reflation”. Oil above US$60 per barrel, a doubling of key global freight indices in a year and signs of Covid and anti-globalisation trade friction suggested to us a degree of structural, rather than purely cyclical, inflation creeping in. This matters, and not just for bonds.

Pick a number between US$15 trillion and US$50 trillion. At the lower end of that range is the amount of direct fiscal stimulus provided by global governments in recent times. Adding in central bank balance sheet expansion and taking a guess at associated cheap intermediated financing and you get toward the upper end. In 2020, US GDP was around US$22 trillion. You see why we believe inflationary pressures are rising.

Central bankers are telling us inflation isn’t a problem – that classic “broad and sustained rise in the price of goods and services”. Bond markets aren’t so sure. For now, other asset classes from Tesla shares through Bitcoin to oil and gold just about believe them and of course are supported by the abundance of cheap money in the system.

The remainder of this quarter will be fascinating. Macro data is improving (although we know Q1 will be poorer than Q4 2020) and against that, we are likely to hear everyone from Jerome Powell to Christine Lagarde tell us rates are on hold, urging us to dismiss inflation and keep buying bonds at levels still close to all-time highs.

We will be discussing the outlook for bonds for the next 10 years in a 90 minute virtual event this Wednesday (10 March). We will be joined by fixed income fund buyers and traders. If you are interested in watching this event, please contact clientservices@liontrust.co.uk.

Rates

It was the worst month for many sovereign bonds in about a decade. We started with a duration of about 2.75 years^† and ended February a little longer, close to 3.25 years. We tried hard to avoid being sucked into a falling market and we largely succeeded, although adding a little more market risk with many sovereign bonds at one year yield highs was in line with our process.

We continue to believe that:

1. Yields will go a little higher through H2 2021
2. Central banks will try to prevent too big a sell off too quickly
3. Prices still need to fall materially before we commit clients’ capital

Most of our duration was in the core part of core markets. We had few very short bonds and even fewer very long ones. That focus generally did us well, with all G7 bond markets falling and curves “bear steepening” for most of the period.

A couple of our cross market positions worked well. In particular, the long position in Switzerland versus Germany helped performance. We remained positively predisposed toward US bonds and the shorter dated holdings there fared well compared with similar assets in the UK, for example.

Australian bonds were very volatile, falling precipitously. Thankfully for us, the “short” we had against them was in Canada, the next best placed in the most ugly contest. Following the late month sell off, we reduced our Canadian short and added to Australia, funding each from residual US positions.

We also took advantage of huge curve gyrations caused by a horrendous US Treasury auction late in the month. Those long dated bonds I mentioned had their (relative) moment in the sun and we sold more of those in Germany and the US, buying 5 year bonds – US 5 year bonds had priced for nearly a 1% rate hike from the Federal Reserve in the next year or so. Even us bears think that is overdoing it.

Allocation

Corporate Bonds quite like inflation, at least initially. It was no surprise that both investment grade and high yield performed better than sovereign debt during the month. If inflation and/or yields continue to rise, risk assets will be vulnerable. We reduced our investment grade weighting closer to 40% than 50% (note 50% is our expected “neutral” weight in the Fund through the cycle). Similarly, in high yield we trimmed a little, ending close to 20%. The Fund retained its cross market position preferring the European iTraxx Xover CDS Index to the riskier US HY CDX equivalent, part of the overall reduction in high yield due to an addition to the latter.

Selection

It has an end of cycle feel to it – too much money chasing too few corporate bonds at too low a premium to sovereign debt. There was a long list of the usual suspects, taking advantage of cheap financing just in case it ends. As is often the case, for us it was more about not buying, rather than buying purportedly cheap new bonds.

We did rotate a little:

• Eli Lilly – we reduced exposure to the drugs manufacturer purely on value. We have had a reasonable weighting to the Pharma sector for at least a year, but now we think there isn’t much value left at current levels.
• Becton Dickinson – by contrast, medical supplies companies have fared a little less well as healthcare budgets have been directed to vaccine providers. However, the infrastructure is still in demand, so we took the opportunity to add bonds in this US$70bn market cap company.
• Ardagh Packaging – packaging, need I say more? High demand, unlikely to reduce anytime soon. Ardagh is a classic high yield name and is an easy to understand business, run with a lot of leverage, currently not paying a lot for its debt but with nicely expanding, GDP busting revenue growth.

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

*Source: Financial Express, as at 28.02.2021, accumulation B share class, total return (net of fees and income reinvested.

**Source: Financial Express, as at 31.12.2020, accumulation B share class, total return (net of fees and income reinvested. 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.