Liontrust GF Absolute Return Bond Fund Q3 2021 review | Insights

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

The Liontrust GF Absolute Return Bond Fund (C5 share class) was flat in sterling terms in Q3 2021 and the IA Targeted Absolute Return, the Fund’s reference sector, returned 0.5%. The Fund’s primary US dollar share class (B5) returned 0.1%.

Market backdrop

The quarter started with a slowing in the pace of growth and fears about the spread of the Delta variant of Covid-19; these led financial markets to question the reflation trade. We just view this as a tempering of over-exuberant market expectations. Ultimately, growth is still going to be very strong, with global activity likely to expand by just under 10% in nominal terms in 2021. Recently, the mix of this has altered with a little more emphasis on global inflation, estimated to be 3.6% even before the recent increases in energy prices, and real growth numbers edging down towards 6.1%.

Examining the three largest drivers for economies currently: we are witnessing a boom in goods consumption with services accelerating as lockdown restrictions ease; inflation has jumped – a good proportion of which will prove to be structurally sticky rather than transitory – and employment is recovering, albeit with lower participation levels until people are enticed back into the labour force. Monetary conditions should be being tightened, or at least the loosening halted, given this backdrop. Thus, we saw the rally in bond yields in July as one that should be opposed, and we reduced the Fund’s duration accordingly.

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 with developing nations 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.

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 being harder to justify with economies recovering and high vaccination rates. A slowing of the pace from approximately €80 billion a month was announced in September with the run rate appearing to be €10-20bn lower. PEPP looks set to expire in March, but the APP (Asset Purchase Programme) could be scaled up to offset some of the shortfall if the hawks get overruled.

In the US, the Federal Reserve has given a very strong hint that tapering will be announced at its November FOMC meeting with fresh net purchases ending by June 2022. Note the stock versus flow distinction here; this only means the Fed would stop expanding its balance sheet – reinvestment of coupons and bond maturities to maintain the value of the stock will still occur.

The majority of the rise in bond yields occurred in the second half of September as central bankers in the US and Europe acknowledged explicitly a mild concern that prices for some goods and services had risen a bit and could remain elevated. Pictures of panicked petrol purchasers at UK fuel pumps, and of ships waiting to dock in California suggested more than mild concern was required. The last available G7-wide CPI data for the year to end of August showed inflation rising at 3.9%. Most, ourselves included, would suggest that number under reports actual consumer price rises and that, in the short term at least, CPI could move even higher.

We have said repeatedly that the past decade of free money has created economic imbalance and asset price bubbles. Powell and Lagarde now seem to agree. Sovereign debt started to fall as investors realised the “buyer of last resort” may not be around as much. With low bond yields being the prop that supports so many other asset prices, the next few months could be quite challenging for riskier investments despite the strong growth outlook.

Investment grade credit is expensive compared to its own history. There might not be an immediate catalyst for investment grade credit spreads to widen, but expensive valuations and stretched investor positioning sends us a strong signal that there will be a much better chance to buy in the future. The Fund is defensively positioned and very much in capital preservation mode; more on this below.

Carry Component

We split the Fund into the Carry Component and three Alpha Sources for clarity in reporting, but it is worth emphasising we manage the Fund’s positioning and risk in its entirety. As a reminder, the Carry Component invests in investment grade bonds with <5 years to maturity; within this there is a strong preference for investing in the more defensive sectors of the economy.

Regarding the overall Fund shape, with credit spreads at tight levels the proportion of the Fund in the Carry Component continues to be run in the 55-60% range. This has freed up risk budget to implement more alpha trades particularly within Rates. With frequent tenders and maturities within the Carry Component there is a constant need for new purchases. Corporate bonds bought during Q3 included those from issuers such as Ashtead, Marsh & McLennan, and Sealed Air secured debt (which reaches less than 5-years maturity during October); within financials, Intesa Sanpaolo and Capital One were bought.

Alpha Sources

Rates

The most significant move during the quarter was in managing the rates beta, the Fund’s overall duration. The Fund started and finished Q3 2021 with a duration of approximately 1 year^†. As a reminder, the permitted range is 0-3 years, and it would take a huge improvement in valuations to entice us to a 1.5-year “neutral” position. During July we believed government bond yields had overreacted to growth estimates being trimmed and duration was reduced to 0.6 years. It remained at this level until the sell-off in September when we returned to the 1-years’ worth of exposure.

The Fund retained both its long Swedish 5-year bonds versus the German 5-year BOBL future and long 10-year France versus Germany positions. The spread between both of these relationships was flat during the quarter, with the carry from both being mildly additive through the period.

Staying in Europe, the Fund made money again out of going tactically long Swiss debt relative to Germany. The 10-year tenor was our focus this time, a poor supply technical having created the opportunity in the Swiss bond market. Once the overhang had cleared, the mean reversion occurred and 5 basis points of profits were generated; these incremental returns all help. Another repeat position that we discussed in last quarter’s report is the Canada versus US 5s10s box trade. This was successfully closed out having made a handful of basis points profit for the Fund.

In the antipodean markets we took profits on a successful position in 3-year Australian debt. A new position was entered into: long New Zealand 10-year bonds relative to the Australia 10-year bond future. We believed that with the Kiwi bond market already discounting interest rate rises, the differential between the two would narrow; the thesis proved to be correct but the entry point to the trade was premature. The position was offside during Q3 but has been closed out at essentially flat to the entry level in early October.

Allocation

There were no market neutral Allocation positions taken during the quarter – valuation discrepancies tend to occur in periods of credit market dislocation.

Selection

Returns within Selection were once again incremental in nature with outperformers only able to add a couple of basis points to performance in the low spread volatility environment. We continue to rotate successful holdings into new ideas, thereby avoiding accumulating too much risk within this alpha source. The most significant sales were of Vodafone subordinated bonds and the long-dated Euro-denominated Danaher bonds. Purchases included Southern Company, a regional US electrical utility, Castellum, a Swedish property company, and AIA, the Asian insurance giant. Additionally, a new issue from Pershing Square Holdings, a FTSE 100-listed investment company, was bought; the Fund’s weighting in the name was temporarily high at month end with the make-whole tender for the 2022 debt the Fund did own settling in early October.

And finally…

The Fund is now categorised as Article 8 under SFDR, although there were minimal changes to our investment process as we have always had ESG factors embedded within analysis.

Discrete 12 month performance to last month end**

	Sep-21	Sep-20	Sep-19
Liontrust GF Absolute Return Bond C5 Acc GBP	0.5%	3.0%	1.7%
IA Targeted Absolute Return	6.5%	0.1%	0.9%

Discrete data is not available for five full 12 month periods due to the launch date of the portfolio.

*Source: Financial Express, as at 30.09.21, total return (net of fees and interest reinvested), C5 class.

**Source Financial Express, as at 30.09.21, total return, C5 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.

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Key Risks

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

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 which may have the effect of increasing volatility. Some of the Funds 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

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