The Liontrust Strategic Bond Fund returned -0.1%* in sterling terms in August. The average return from the IA Sterling Strategic Bond sector, the Fund’s comparator benchmark, was 0.3%.
Market backdrop
We have talked a lot this year about the economic recovery from the pandemic being very uneven in nature. It is uneven by sector and, of course, by country; developing nations have been struggling to access vaccination doses. The other privilege that developed nations take advantage of is having a hard currency, particularly those with the luxury of controlling a global reserve currency. Thus, we have seen rising interest rates across swathes of Latin America and central/eastern Europe whilst the US and eurozone debate remains over when to slow the pace of printing money. Or maybe developing nation central bankers just take inflation more seriously? In fairness, there is little choice and only the privilege of a hard currency can buy you the time to see if current inflation is indeed transitory in nature.
At the virtual Jackson Hole meeting, Fed Chair Jay Powell reiterated his view that most of the inflationary impulse in the US will wane. We believe that price pressures are diverse enough for inflation to be sticky, driven by ongoing strong consumption, and that a retreat from the 5.4% year-on-year CPI rate will head towards 3% not 2%. To a certain extent, Powell doesn’t care, and that is one of the advantages of flexible average inflation targeting – his main focus presently is on employment. In that regard the recovery continues, and so Powell effectively flagged that tapering was likely to be announced this year. This delaying of the inevitable should, at the margin, lead to yield curve steepening and we continue to avoid longer dated (over 15-year) duration exposure.
Meanwhile in Europe, the ECB hawks have been making a concerted effort to point out that the E in PEPP stands for emergency. The current higher pace of quantitative easing-based bond purchases is harder to justify with economies recovering and high vaccination rates. A slowing of the pace from approximately €80 billion a month to the prior €55 billion is likely to happen, and the PEPP looks set to expire in March. This does not preclude other QE occurring, it merely removes one excuse for monetary debasing.
Some of the need for monetary stimulus will be alleviated if the fiscal side of the equation continues to take up the slack. We have seen the first disbursements from the EU recovery funds and only heard the faintest of whispers of reintroducing fiscal rules across the euro currency bloc somewhere down the line. The fiscal side may also be boosted if a more left-leaning coalition ends up forming after September’s German elections. It can take months for a possible three-way coalition to be formed so don’t get too excited; besides, the constitutional balanced budget will prevail during normal times.
Rates
The Fund finished August with a duration of 2.5 years. We took advantage of the volatility to add a few basis points of performance, mainly focussed on the US ultra-Treasury future. The overall duration shape of the Fund saw a small increase to exposure reflecting the rise in bond yields during the month. This increase is very much at the margin; the strategic position remains that government bonds are fundamentally overvalued. The 2.5-year duration exposure reflects a low beta approach – around half of our 4.5-year neutral exposure and 5 years below the Bloomberg Barclays Global Aggregate’s 7.5 years of interest rate risk.
One new cross-market alpha position was established this month, namely long Swiss 10-year bonds against the German Bund future. The yield differential had got to 10 basis points and we would target equal yields to take profits. To fund this position, we sold some 6-year US Treasuries and replaced the duration exposure with the 5-year US Treasury future.
Allocation
There was no change to the investment grade weighting during August: the Fund holds approximately 40% net in investment grade credit, split between 45% in physical holdings and a 5% risk-reducing overlay. We deem 50% to be a neutral weighting. The one part of the credit markets we still see value in is high quality high yield. The Fund has a 23% weighting in high yield, slightly above the neutral positioning of 20%. We are still avoiding the worst segments of the market by sector and rating; the Fund has zero exposure to CCC (and below) rated credit.
Selection
In last month’s commentary we mentioned our intention to pick up a bargain or two in the quiet August markets and we did manage to find three decent new opportunities. To call these bargains might be stretching things a little, but they are certainly cheap corporate bonds compared to the market and should add value over time.
Starting in investment grade, we bought 20-year debt in Becton Dickinson, a US medical devices company. As its credit metrics improve and ratings agencies deliver anticipated upgrades over the next few quarters, we anticipate spread tightening from its current 160 basis point level.
Next, we have Castellum, a Nordic real estate company which is mid-BBB rated. The Fund invested in its inaugural euro hybrid debt issue which creeps into the high yield rating category due to its subordination in the capital structure; obviously the bond is still senior to equity. We believe the yield of 3.125% is compelling but are always wary about taking too much risk in this type of bond. We sold AIG hybrid bonds to avoid adding to the subordinated bond weighting within the Fund.
Finally, in traditional high yield we bought bonds issued by Altice. This single B rated cable telecommunications company is very well known to bond investors and is a regular issuer into the market. It is rare for it to leave value on the table, but a spread of 490 basis points for its 8-year secured debt compensates investors very well for the risk of aggressive corporate financing that Altice sometimes undertakes.
Discrete 12 month performance to last quarter end (%)**:
|
Jun-21 |
Jun-20 |
Jun-19 |
|
|
Liontrust Strategic Bond B Acc |
5.1% |
2.8% |
5.5% |
|
IA Sterling Strategic Bond |
6.1% |
3.8% |
5.3% |
|
Quartile |
3 |
3 |
2 |
*Source: Financial Express, as at 31.08.2021, accumulation B share class, total return (net of fees and income reinvested.
**Source: Financial Express, as at 30.06.2021, 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. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates.
Investment in the Strategic Bond Fund 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 Fund may invest in derivatives. The use of derivatives may create leverage or gearing. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead.
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.
