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Liontrust GF Strategic Bond Fund

Q3 2021 review

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 Liontrust GF Strategic Bond Fund returned -0.5% in US dollar terms in September. The average return from the EAA Fund Global Flexible Bond (Morningstar) sector, the Fund’s reference sector, was -0.4%.

 

Market backdrop

Well, it had to happen. Investors, returning from summer holidays took fright. Why? Inflation. Why now? The promise of central bank action.

Indeed, the Bank of America UK Gilt index fell around 3.8% in September, to stand down over 7.6% for the year to date. So much for a risk-free store of value. Equites in general struggled. Most corporate bonds, high yield in particular, seemed unfazed.

Inflation

Central bankers in the US and Europe acknowledged explicitly 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 most recent G7-wide CPI data for the 12 months to end August showed inflation rising at 4%. Most, ourselves included, would suggest this number under-reports actual consumer price rises and conclude that – in the short term at least –CPI could move even higher.

Why now

Inflation is not necessarily “bad”. Indeed, the G7 has been trying to find it for a decade. However, contrary to economic logic, if consumers expect lots of inflation (as opposed to hyperinflation of course) they often hoard cash so as to be able to pay for essential goods and services in the future. Consumer confidence in the US has plunged to a decade long low, with surveys citing inflation expectation as a core reason. And the stock market, the darling of almost all central bankers, really doesn’t like a worried consumer

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. Both the US Federal Reserve and European Central Bank appear to be set to taper bond purchases – reducing monetary accommodation, as distinct from tightening monetary policy. Sovereign debt started to fall as investors realised the “buyer of last resort” may not be around as much. Equities, led by tech and so-called growth stocks started to fall on the understanding that bloating a balance sheet with cheap leverage might not be such a good long-term strategy after all.

Rates

We raised our duration from 2.5 years at the end of August to 3.0 years by end of September. Since July we have added about 40% to our duration exposure (from 2.2 years to the 3.0 today). That sounds dramatic. That sounds as if we believe rates markets offer value. To be clear: we still have a duration more than four years below the global bond index and about six years lower than leading gilt indices. We believe rates have further to rise. Once released, the inflation genie is difficult to put back in his bottle.

As always, some rates markets fared better, some worse. UK Gilts were in the eye of the storm – yields moved close to 1%. We had been “short” and closed that out as part of our duration increase. Likewise, Germany fared worse than Switzerland and the long Swiss position reported last month was closed at a nice profit.

About the only poor alpha position was a US curve steepener, where we owned 10 year bonds and were short 30 year bonds. In mid-September that moved against us. However, by month end investors had realised the Federal Reserve might be a little late to raise rates, and long-dated bonds fell nicely.

We also now own a small amount of New Zealand bonds, with a corresponding short in Australia. The former is expected to raise interest rates in October. We believe that move is in the price. Australian debt on the other hand is yet to reflect an inflationary environment.

Allocation

There was not much change to asset allocation. We remained modestly overweight higher quality high yield bonds (about 23% against our neutral position of 20%). High yield performed well during the period. Or rather, the core, quality markets we invest in did – anyone unlucky enough to be sucked in to “global” high yield (which looks a lot like second-rate emerging market grouping to me) will be watching Evergrande extremely closely. In the event of an unmanaged default (less than 50% probability we would say), core high yield would not be immune. However, we would welcome a repricing and, all other things being equal, see it as a chance to increase yield and risk in the portfolio in return for more sensible expected levels of reward.

Likewise, investment grade was largely unchanged. We see it as fully valued and continue to avoid AT1, most hybrids and to hold about 40% against our expected 50% of portfolio value. Yields on sovereign bonds have not yet reached the level where they look attractive compared with low default investment grade. That time may come soon – if so, we think it’s a warning of a good 10% core equity correction.

Selection

The bond market was awash with new supply in September. No surprise. And perhaps of even less surprise were prices – most new issues offered poor or zero premia to secondary markets. So, we watched most come and go, secure in the knowledge that if the market turns, it is often the most recent bonds to market that suffer the most. As we said, we have only 40% investment grade against a 50% neutral level and are happy to pick off bonds from potentially over-levered competitors.

We did buy a couple of names in the finance space. First, we added AIA Insurance subordinated debt, which was still A rated. The company is well diversified, most of its businesses are highly regulated and it has a nice solvency ratio. It also helps that it is multi-line and multi-geography. Additionally, it is not a frequent issuer so we expect a rarity premium to attach to the bonds over time.

Second, we bought back into an old favourite: Pershing Square. Most will recognise this well-known investment vehicle. It is significantly over-capitalised and we believe a little under-rated. The new issue gave us an opportunity to add BBB+ risk for a yield more than double that available on the equivalent US Treasury at the time. Recently, to receive that kind of yield has meant fishing in the high yield pool. Needless to say, we were reasonably circumspect and bought senior bonds.

Outlook

Government bonds continue to be under pressure. Inflation continues to rise. Central banks appear to have run out of patience. As Q3 ended, only the sovereign market seemed to have noticed. If yields do continue to rise, equities and the lower echelons of high yield could be vulnerable. That would give us an opportunity to increase our currently low level of fund beta.

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

 

 

Sep-21

Sep-20

Sep-19

Liontrust GF Strategic Bond B5 Acc

3.18

6.40

7.39

EAA Fund Global Flexible Bond - USD Hedged

4.27

3.42

6.67

 

*Source Financial Express, as at 30.09.21, total return, B5 share class.

**Source Financial Express, as at 30.09.21, 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.

Understand common financial words and terms See our glossary
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

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This 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. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and if you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

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