Liontrust GF High Yield Bond Fund

Q2 2019 review

The Fund (C5 accumulation class) returned 2.7%* in sterling terms in Q2 2019 versus 2.3% from the ICE Bank of America Merrill Lynch Global High Yield Index (GBP hedged) and a 2.3% average from the IA Sterling High Yield sector. The primary B5 US dollar share class returned 3.2% versus 2.8% from the ICE Bank of America Merrill Lynch Global High Yield Index (USD hedged).

 

Global high yield market

Global high yield had a mixed but ultimately decent second quarter, producing a return of 2.8% (USD), 2.0% (EUR) and 2.3% (GBP). April carried on the strong returns seen in the early part of the year, only to see risk sentiment dip in May (mainly on weaker economic data and trade war concerns) and the market produce its first negative month of the year.

However, the market came back in anger in June, aided in no small part by ‘dovish’ central bank rhetoric. You will remember the early 2019 rally was also sparked by central bank action: as one might expect at this late stage of what has been the longest US economic expansion in the last 150 years, the market is clearly hyper-sensitive to the actions of the Federal Reserve chairman, European Central Bank (ECB) president and their colleagues.

European high yield had a stronger quarter than its US counterpart, generating a return in USD of 3.2% versus 2.6%. The outperformance of higher quality has been an ongoing theme in high yield, with the trend only strengthening in Q2.

Given the central bank-driven rally we have seen, this is not surprising. BB bonds, the highest-rated part of the market with typically lower coupons and longer to maturity, tend to have higher duration or interest rate sensitivity and therefore perform very well in a market where ‘risk assets’ are stable/rallying at the same time as ‘risk-free’ rates are rallying.

Liontrust GF High Yield Fund

With our bias towards higher-quality high yield credit, this was undeniably a good environment for the Fund. We saw positive performance from most of the Fund’s holdings and a very small number of only modestly negative contributors.

The top contributors included Netflix, UK gas producer Neptune, Canadian ply-board manufacturer Norbord, UK biomass energy producer Drax and US casino giant MGM.

We have an overarching view that interest rates are too low in the face of stable, near-target inflation and slowing yet reasonable growth in developed market economies. Our view is particularly strong in terms of European rates and we therefore have a substantial German interest rate hedge in the Fund, combined with a much smaller US rate hedge. As rates have rallied strongly, these have been a drag on the performance of the Fund.

Portfolio activity in the quarter saw us initiate holdings in credits including:

  • EG Group, a UK-based, owner-operated company involved in the global consolidation of petrol station retail forecourts
  • Shaeffler, a German-based supplier of auto and industrial bearings
  • Antero Resources, a US-based gas producer with substantial use of hedging to manage commodity price exposure
  • Liberty Global-owned telecommunications company UPC.

The Fund no longer has holdings in Rabobank, Bank of America and Citigroup. Each were bonds providing capital to banks and we sold on valuation grounds. Elsewhere we sold out of gambling machine manufacturer Scientific Games bonds, which are junior in the capital structure, based on our view the company has not sufficiently reduced debt.

Outlook

The US high yield market offers a yield of around 6% (subtract around 2.7% for EUR hedged and around 1.25% for GBP hedged). European high yield offers a yield of 3.1% (add around 2.7% for USD hedged and 1.1% for GBP hedged).

Our preferred measure of credit spread value is to use a sub-index that excludes the lowest-quality credit and energy, based on our quality bias and preference to avoid thematic sectors (for which energy is the current poster child). Using this measure, the market is a little expensive but not outrageous (the current spread is 3.2%, whereas we are enthusiastic about value at 4%).

In this environment of central bank generosity, we could certainly see the high yield market rally further. Indeed, lower-quality parts of the market could ‘catch-up’ if investors decide to try and squeeze out the last of the juice.

That being said, our process is designed to encourage us to add market beta when we see good value and reduce risk when we see the opposite. For example, at the start of the year, the Fund had ‘spread duration’, or sensitivity to general credit spread movement, above 4. By the end of June, having actively reduced longer-maturity bonds, we had reduced spread duration to around 2.1. Moreover, throughout its life, the Fund’s exposure to CCC and lower has been less than 5%, and today is a mere 1.3%. Bonds issued by oil and gas companies remain less than 5%, mining companies less than 1% and banks less than 3%.

As mentioned, we are negative on the value offered by government bond yields, which directly impacts the high yield market as we earn the spread over government debt. With German interest rates at all-time lows, we feel the aforementioned interest rate hedges continues to play an important role in reducing the duration of the Fund.

The cycle is long in the tooth, which in and of itself is not a reason for it to end any time soon. We still believe the likes of the US, Germany and UK economies are in reasonable health and companies are, generally speaking, strong enough for defaults to remain relatively low. That being said, experience tells us this is not the time to be reaching for yield and therefore risk. We will not abandon our quality bias or our desire to minimise thematic risks, be they cyclical (commodities, banks) or structural (disruption, such as the risk faced by traditional retailers and autos, for example).

In summary, with around 5.5% cash, the Fund is reasonably well invested. We have reduced spread duration and, with around 13% of portfolio value in liquid interest rate derivatives positioned to protect from rising interest rates, we believe the Fund can be considered to offer a relatively low duration, high-quality exposure compared to the broad high yield market.

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

 

 

Jun-19

Liontrust GF High Yield Bond Fund C5 Acc (GBP hedged)

7.1

ICE Bank of America Merrill Lynch Global High Yield (GBP hedged)

6.5

IA Sterling High Yield sector average

5.1

 

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

 

*Source: Financial Express, C5 share class, total return, net of fees and interest reinvested. Data correct as at 03.07.19. The primary share class for this Fund is in US dollars (B5) but we are showing the C5 sterling-hedged class to compare against the IA Sterling High Yield sector.

 

Fund positioning data sources: UBS Delta, Liontrust.

 

For a comprehensive list of common financial words and terms, see our glossary here.

 

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. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move 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.

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.

Thursday, July 11, 2019, 10:57 AM