Liontrust GF SF European Corporate Bond Fund

Q2 2019 review

The Fund returned 2.1% in euro terms over the quarter, slightly lagging the iBoxx Euro Corporate All Maturities Index’s 2.2%*. 


Despite a sharp fall in May, financial markets continued the good start to the year by posting positive returns over the quarter, with concerns over trade and global slowdown offset by talk of more accommodative central bank policy. This led to corporate and government bonds both performing well over the period, as investors were encouraged by central banks’ willingness to prolong the economic cycle.

Corporate bonds outperformed government debt over the period, which saw the portfolio benefit from its overweight credit position. Sector allocation and stock selection both contributed positively to returns, particularly our core weightings in banks, insurance, telecommunications and utilities, which were among the best-performing sectors over the period.

From a stock selection perspective, some of our higher-beta subordinated bonds and higher spread duration positions particularly benefitted from the risk-on tone in markets.

This was offset by the negative contribution from the fund’s short duration position however, as developed market government bond yields fell sharply. German 10-year Bund yields moved further into negative territory, falling 26 basis points (bps) to reach an all-time low of -0.33%, while US 10-year Treasury yields fell 40bps to 2.01%. Despite rising following the extension to Article 50 at the start of the quarter, UK 10-year Gilt yields fell 16bps to close the period at 0.83%, nearing the all-time low of 0.74% post the Brexit vote in 2016.

As stated, after initially continuing the trends from the first quarter, global markets’ buoyant start to the year came to an abrupt halt in May, as escalating trade tensions saw a flight to safe haven assets. The US increased the tariff rate from 10% to 25% on $200 billion of Chinese imports, which saw the latter respond in kind by increasing tariffs on $60bn of US imports to 25%.

Combined with further deterioration in economic data over the period, particularly employment and consumer figures, these developments heightened concerns about the prospect of a global economic slowdown. This prompted central banks to take centre stage towards the end of the quarter, with a strong dovish response easing investor worries.

Having been targeted by President Trump for not doing enough to support the US economy, Fed Chair Jerome Powell said the case for more accommodative policy has strengthened with "an ounce of prevention worth a pound of cure". This was further supported by eight Fed members who are now advocating a cut in interest rates before the end of the year, which would be the first since 2008.

Not to be outdone, European Central Bank (ECB) President Mario Draghi stated the Bank is also prepared to cut rates, as well as potentially extending its quantitative easing (QE) program in order to bolster the Continent’s economy if required. However, he also reiterated the ECB's stance to keep rates on hold until at least the summer of 2020.

In the UK meanwhile, the Bank of England continued to be less dovish than its peers as economic data proved more resilient, with headlines instead dominated by Brexit developments. After avoiding a no-deal scenario by agreeing a further Article 50 extension until 31 October, Prime Minister Theresa May announced her resignation after a much-maligned spell in the role. Her decision reignited concerns of a no deal, particularly with Boris Johnson the frontrunner in the ensuing Conservative leadership race.

He faces Jeremy Hunt in the final round of voting, with the result announced on 22 July. Whoever wins, there has been little to suggest how they will be able to overcome the current stalemate, particularly given the divide among the Conservative party, and parliament likely to reject no deal regardless of who becomes prime minister. It also raises the possibility of a general election, which would require an extension to the current October deadline, as well as significantly threatening the Conservative/DUP coalition's slender majority.

Investor concerns were further exacerbated by European Parliamentary election results, which saw Nigel Farage's Brexit party dominate in the UK. Across Europe however, while populist parties gained seats, it was not nearly as many as were expected. The notable exception was Italy, sparking fresh fears over the future of its fractious relationship with the EU.

Trading activity over the quarter was predominantly relative value led, with a number of switches within the portfolio.

We completed a cross currency switch within Lloyds for example, moving out of euro-denominated bonds into US dollar equivalents after the yield and spread pick up on offer widened back out to attractive levels during the sell-off in May, compensating for the cost of hedging.

Following the sell-off, there was also value on offer in subordinated bonds, which underperformed relative to senior debt and were trading at attractive discounts. We switched out of Swiss Reinsurance senior bonds, using the proceeds to top up positions in SCOR and Aviva subordinated paper to exploit this opportunity. Similarly, we also switched out of RBS senior bonds into Societe Generale senior non-preferred bonds.

We increased our exposure to EDP, which has embraced the energy transition by increasing its renewable energy capacity significantly over the last decade. The company is currently the second-largest green energy producer in Europe, with over 70% of power generation coming from renewable sources. 

Over the quarter, we increased the fund’s duration position to 2.5 years short relative to its benchmark, up from two years, as we continue to believe government bonds are overvalued and expect yields to rise as concerns over a no-deal Brexit and global trade wars abate. That said, fears of no deal Brexit would increase under a Boris Johnson premiership.

We increased the short position to the German market, where we see the most value after yields reached all-time lows. We also established a short to the US following a significant repricing in Treasury yields over the period, expressing the position through the two-year point of the curve where we see the greatest opportunity given the current inversion, with two-year yields moving higher than five-year. The portfolio’s current positioning is 2.25 years short to the German market, with a 0.25 year short to the US.

We continue to believe the macro backdrop for credit markets remains positive, with concerns over economic slowdown – largely driven by trade fears – offset by talk of more accommodative central bank monetary policy. Meanwhile, default rates remain low and we still see robust trends in corporate earnings.

Corporate bond valuations have continued to recover from the lows seen in Q4 2018 and we see scope for further improvements as technical and sentiment concerns subside, shifting focus back to relatively strong underlying fundamentals. As we have said before, our core sector preferences within insurance and telecoms are supported by attractive valuations and higher credit quality and remain unchanged over the longer term.

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

 

 

Jun-19

Liontrust GF Sustainable Future European Corporate Bond A5 Acc

4.3

iBoxx Euro Corporate All Maturities Index

4.8

 

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

*Source: Financial Express, as at 30.06.2019, in euros, total return (net of fees and income reinvested). Data correct as at 03.07.19.


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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.

Monday, July 29, 2019, 2:39 PM