Liontrust GF Strategic Bond Fund

The Liontrust GF Strategic Bond Fund returned -1.9%* in US dollar terms in January. The average return from the EAA Fund Global Flexible Bond (Morningstar) sector, the Fund’s reference sector, was -1.4%.

Market backdrop

In 2021 there was a huge debate in financial markets about inflation; those that sided with the high and sticky inflation camp proving to be correct. US consumer price inflation is likely to be peaking around its current 7% level, but last time we had 7% inflation interest rates in the US were at 13%! Eurozone inflation is presently 5.1%, with the peak still to come. But the inflation debate is a 2021 story; the focus in the first month of 2022 has been about how G7 central bankers will now react.

The Federal Reserve’s response has been to announce an end to quantitative easing in March. They have also strongly guided to rates being increased then too. There is debate about whether the first hike will be 25 or 50 basis points, consensus currently favouring the former. Quantitative tightening, the shrinking of the Fed’s balance sheet, is anticipated in 2022. The bond market was already expecting higher rates, but the timing has been brought forward; by the end of January 5 hikes were priced in to markets for 2022. It has indeed been a brutal start to 2022 for bond investors.

The ramifications of higher rates have been felt across all financial markets. It has been over 20 years since I worked on equities, but even I can spot the obvious performance differential between value and growth over the last few months. At index level this is epitomised by the FTSE100 outperforming the NASDAQ index by over 10%.

Back in the comfort zone of fixed income assets, credit spreads came under pressure in both investment grade and high yield. Focusing on the latter, both US and global high yield indices had their worst ever January total returns, down 2.75% and 2.42% respectively. European high yield was down 1.53%, which was the second worst January in its 25-year history (2008 was the worst). I would attribute most of this to the fears around the proverbial monetary tide going out. However, a secondary impact is the bond markets’ fears of outflows; historically these frequently follow periods of market weakness even though valuations have improved. We have maintained the Fund’s high yield weighting but rotated some holdings within this to increase the Fund’s exposure to a rebound in prices.

Regarding sovereign bond valuations, the short end of the US Treasury market is now discounting a normal tightening cycle. Compared to the expected path of rates, or just the likelihood of making a positive nominal return, 5-year US Treasuries now look OK. We retain a low duration approach, but have rebalanced to increase weightings at the short end of the yield curve during January. Obviously, in real terms bonds remain hideously expensive, but that’s simply financial repression by monetary authorities.

The ECB is still easing policy, but the markets are also now testing its resolve. 10-year Bund yields turned positive during January. Spreads of peripheral European countries (peripheral is the market’s term, not mine, as I personally find it demeaning to over a hundred million people in those nations) started to come under pressure. The re-election of Mattarella as Italian president at the end of the month helped to stem this move though. The continuity of Draghi as prime minister should enable the necessary domestic policies to be implemented to access large European disbursements.

I should also mention the Bank of England. At the time of writing this commentary, it has yet to have its February meeting, but a rate rise is completely anticipated. In a recent podcast with a journalist, I stated I would eat my metaphorical hat if they don’t raise rates at their February meeting so I’d already declared. The gilt market has then priced in a further four hikes this year. Maybe the UK parties aren’t as much fun after all.

Rates

The Fund still has its core strategic position of having a low beta duration exposure with headline duration unchanged over the month at approximately 3.25 years^†. Underneath this has seen a high level of activity in the Fund. The US yield curve 5-year versus 30-year flattened intra-month to 50 basis points, at that level we said we would reduce the long-end exposure and we did by selling 30-year futures into their 5-year equivalents. The Fund retains some long dated credit in the US and, if the curve flattens further, we will hedge out any duration contribution from this too. Furthermore, we also switched some 10-year US Treasury exposure into the 5-year; this shorter-dated bucket now clearly being our favourite part of the US market with over 1.25 years of the Fund’s total duration contribution emanating from it.

On a cross market basis, we closed out the successful short of Canadian bond futures relative to the US. A new position was established in Europe: long French 10-year debt relative to German 30-year debt, as the relationship had reached very stretched levels. It is rare to be able to pick up yield undertaking this switch.

Allocation

The Fund’s high yield weighting was effectively unchanged over the month, finishing January at 25.2%, overweight compared to our 20% neutral position but with a strong bias for quality. The volatility did afford us the opportunity to rotate within the holdings.

Investment grade exposure remains in the 40% ballpark, underweight compared to a 50% neutral positioning stance. Valuations improved markedly during January, so we will look to move toward neutrality soon if spread widening continues.

Selection

Within high yield, we trimmed some of the Fund’s better performers during the month. These tended to be call-constrained higher-quality bonds such as AMS, Drax and CACC. Proceeds were reinvested by small increases in weightings in other holdings, and the CDS index overlay was adjusted (risk increased) too.

Other stock level activity included a purchase of a new issue from Axa in euros and a sale of one of the few sterling denominated bonds in the Fund, Welltower. SFR 2027 debt was switched into a 2029 maturity bond for a decent yield increase and a cash price over 10 points lower.

Finally, we often get asked about the “greenium” within credit; the premium at which bonds with a green label trade at compared to their conventional equivalents from the same issuer. The greenium is normally only a handful of basis points, but during January we switched a green VW bond into a conventional bond of very similar maturity for approximately 35 basis points of extra spread. We care about the ESG credentials of the issuer as a whole and are happy to take advantage of opportunities such as this as other bond managers clearly accept the greenium for their own reasons.

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

Past Performance does not predict future returns

*Source Financial Express, as at 31.12.21, total return, B5 share class.

**Source Financial Express, as at 31.12.21, total return, B5 share class. Discrete data is not available for ten full 12 month periods due to the launch date of the portfolio (13.04.18).

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 Features of the Liontrust GF Strategic Bond Fund

Key Risks 

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