Liontrust Strategic Bond Fund

The Liontrust Strategic Bond Fund returned 1.2%* in sterling terms during April. The average return from the IA Sterling Strategic Bond sector, the Fund’s comparator benchmark, was 0.5%.

Market backdrop

The unilateral imposition of tariffs by the US dominated financial markets during April. President Trump seemed to blink twice during the month, both times predominately driven by pressure from the bond markets. 

On his self-proclaimed “Liberation Day”, President Trump announced a much larger tariff package than was broadly anticipated. For all the talk of fine tuning the reciprocal tariffs, a simple formulaic process seems to have been followed by taking the percentage of trade difference and dividing by two. The sum of these, plus existing tariffs, leads to a blended US import tariff rate in the 23-26% vicinity, although myriad negotiations are ongoing.  This tariff rate is even bigger than the Smoot-Hawley tariffs of 1930; the international retaliation at that time was large, which helped to worsen the Great Depression.

To contextualise this another way, the 2025 additional tariff hikes on the $3.3 trillion of goods imports is effectively a tax increase of $650-700 billion, or a little over 2% of US GDP. Two quick reminders here: firstly, tariffs are paid domestically so are mainly a tax on the US consumer; secondly, even though the US is a relatively closed economy when it comes to trade, the US consumer is so important to global GDP that this does have serious implications for global growth. 

Regarding the inflation impact, I view the tariffs as mainly being a supply shock for goods, with services exempt for now barring retaliation. Whilst they do lower the long-term growth potential of an economy, the current cyclical impact of tariffs will be paramount for the Federal Reserve. At current tariff levels, assuming partial pass through and some substitution effect in goods, US inflation will increase by 1.0-1.5%. Cyclically this is likely to be a one-off jump in the level of prices, not an inflation impulse that persists – or in Fed Chair Powell’s lexicon “transitory.” The problem is that central bank inflation-fighting credibility is still being rebuilt after the farce of previously referring to inflation as transitory when it clearly wasn’t. In my opinion the transmission mechanism from a supply shock boost to prices into a broader inflationary wave is via the labour market. If the labour market is strong such that people can push for higher wages to rebuild spending power post the goods price hikes, then inflation permeates more into the services sectors and creates a feedback loop. The US labour market witnessed exceptionally tight conditions post Covid disruptions but has slowly softened since. Even excluding DOGE-based job cuts, the labour market has fragility to it due to the low level of hiring. A small increase in the layoffs rate would rapidly feed through to higher unemployment. All the policy uncertainty has hit business confidence and therefore investment and hiring – plus consumer confidence and therefore spending. The problem for the Fed is that it will want to be confident that the secondary impact of tariff hikes (via the labour market) on inflation is not happening before it commits to cutting rates. If the Fed does wait too long to cut rates, then the cumulative cuts will have to be larger once they restart.

During the month, reciprocal tariffs – above the 10% baseline – were suspended for 90 days for most countries.  The policy uncertainty had caused a spike in implied volatility in equity, this naturally permeates through to credit markets. There was also a jump in bond market volatility which led to the US Treasury market flirting with being dysfunctional. The most likely cause that I think drove the selloff is a partial unwind of the basis trade. The basis trade is used by hedge funds which sell US Treasury futures and buy similar duration US Treasury bonds to capture the “basis” between them. This is at first glance low risk arbitrage; however, the scale of the positions creates some systemic market risk (I’m old enough to remember LTCM blowing up). These positions can be leveraged up 50 to 100 times so total exposure is estimated to be close to $1 trillion. When market volatility increases the prime brokers providing the leverage ask for margin calls, leaving the hedge funds forced to, at least partially, unwind some of the leveraged positions.

It is further out along the yield curve that has been feeling the strain. This is not due to inflationary fears – the pricing of inflation breakevens in the US TIPS (Treasury Inflation-Protected Securities) market is sending a clear signal that the current bond market view is that tariff inflation will be temporary, with growth concerns mattering more over the longer-term. The steepening of the yield curve is therefore a function of the market demanding an increased “term premium” (effectively a risk premium for lending for longer), or the proverbial “bond vigilantes” have stirred from their slumber. I believe that it was the bond market in April that caused Trump to blink on his tariff plan. However, a 10% universal tariff is still a huge impediment to growth and 145% tariffs on China says that the world’s two largest economies don’t want to do any business with each other. Expect heightened volatility in the bond markets for many months to come.

The second tussle with the bond market emanated from President Trump disapproving of Federal Reserve Chair Powell’s speech, on social media stating that “…Powell’s termination cannot come fast enough.” Trump has never liked Powell and gets very frustrated that the Fed won’t bow to his will. Trump escalated matters further, posting a tirade including referring to Powell as “…Mr. Too Late, a major loser.” When you are running such a large fiscal and current account deficit, you really do need the bond market – any threat to the independence of the central bank is never taken well by the market. More yield curve steepening was witnessed with the aforementioned “term premia” in the US Treasury market rising due to the threat to the Federal Reserve’s independence creeping upwards. US Treasury Secretary Bessent is highly cognisant of the importance of bond yields so I am not sure whether he had a quiet word with Trump or whether the adjustment to the narrative was all Trump’s own work. The next day Trump, when asked about Powell, stated to reporters “…I have no intention of firing him.” The bond market breathed a sigh of relief!

There are two side points here that are worth making. Firstly, the US President does have the right to remove the Chair of the Fed provided there is a just cause. Obviously, this would cause huge turmoil in the bond markets, and it also does not achieve very much. Whilst Trump could appoint a new Chair of the Fed, it is not guaranteed that the Fed Chair would also then be Chair of the Federal Open Markets Committee (FOMC) which sets monetary policy. It is the FOMC members who elect their chair; convention has always been to choose the Fed Chair, but this is not legally binding. Furthermore, Federal Reserve members who are part of the FOMC (membership rotates) have long-term employment contracts that renew over a protracted period. It would need a lot more than one Trump “yes man” being parachuted in to sway the FOMC. Ultimately, if US politicians want the Fed to no longer be independent, they can achieve this through passing an act of law through Congress; but not by Trump just shouting at people until he gets his own way.

Secondly, it is worth a reminder that 30-year yields in the US matter for two reasons; partly the direct cost of servicing the vast amount of US government debt and also because most US mortgages are priced over the 30-year yield. Although the very wealthiest Americans care most about the stock market, the bottom half of the US wealth distribution has 49% of their wealth in real estate, with only 5% in equities (source: Deutsche Bank, Fed).  Trump and Bessent do not want to alienate the US homeowner. 

Fund positioning and activity

Rates

The Fund finished April with just under 6.0 years of duration exposure which is the same level as at the end of March, but this masks some intra-month trading as well as a change to yield curve positioning. During one of the rates markets selloffs the Fund took the opportunity to lengthen duration to 6.5 years; profits on this were banked on the last day of the month. 

On the yield curve front, the Fund purchased US 30-year bond futures. This is the first purchase in the 15+ year maturity bucket for a couple of years. Furthermore, the Fund has also taken exposure to the long end of the UK, buying 2054 maturity gilts and selling UK 10 year bond futures. We believe that the yield curve has steepened enough now to justify some exposure in the Fund. With a total 15+ years maturity bucket exposure of 1.0 years the Fund is still underweight relative to indices but no longer has zero exposure.

Allocation

In March’s commentary we discussed the decompression trade between two European credit default swap (CDS) indices. The Fund had gone long risk (sold protection) iTraxx Europe and short risk iTraxx senior financials as cheap way of buying insurance against any deterioration in market sentiment. The volatility in markets caused by Trump’s tariffs caused this differential to widen and the position was closed out at a differential of 8.8bps.  This generated the Fund a profit of just over 8bps, or saved the Fund money in a spread widening environment depending on how you prefer to phrase these things. By the end of April the differential between the two CDS indices was approaching levels where we would look to instigate the trade again.

The other change during April was an addition to the Fund’s high yield weighting of a little over 5% during the market weakness, with the Fund finishing April with exposure of 21%.

Selection

Stock level activity was driven by the additions to the high yield weighting using our current favourite picks.  Purchase included Kennedy Wilson, Forvia, Ahlmun, and Kedrion. We also sold a couple of high yield holdings whose bonds had outperformed during the widening to redeploy proceeds in the aforementioned attractive opportunities; sales were made of Transdigm and Pinewood bonds.

Discrete years' performance (%) to previous quarter-end**:

*Source: Financial Express, as at 31.03.25, accumulation B share class, total return (net of fees and income reinvested).**Source: Financial Express, as at 31.03.25, accumulation B share class, total return (net of fees and income reinvested).

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.

The fund manager considers environmental, social and governance (""ESG"") characteristics of issuers when selecting investments for the Fund. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay. Overseas investments may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund. The Fund can invest in derivatives. Derivatives are used to protect against currency, credit or interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The Fund uses derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash. The Fund invests in emerging markets which carries a higher risk than investment in more developed countries. This may result in higher volatility and larger drops in the value of the fund over the short term. The Fund may encounter liquidity constraints from time to time. Participation rates on advertised volumes could fall reflecting the less liquid nature of the current market conditions. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.

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