Liontrust GF SF European Corporate Bond Fund

Q1 2019 review

Credit markets posted strong returns as they recovered from widespread weakness in Q4 and a combination of economic slowdown and dovish central bank rhetoric saw corporate and government bonds both perform strongly.

This resurgence in government bonds led to a sharp drop in yields across developed markets, with 10-year US Treasury yields down 27 basis points (bps), 10-year UK Gilts down 28 bps and 10-year German Bunds down 31 bps. This resulted in underperformance from the portfolio’s underweight position to interest rate risk and the severity of yield moves resulted in an inverted US curve, with short-term yields above long term, highlighting concerns over the longer-term economic outlook.

This was more than offset by strong performance from our overweight position to credit however, as corporate bonds outperformed government bonds over the period. The Fund benefitted from strong sector allocation, particularly key overweights to banks, insurance, telecommunications and utilities, as spreads compressed significantly across virtually all parts of the market.

Stock selection was also a significant contributor, particularly within banks as the European sector was boosted by the unveiling of European Central Bank (ECB) plans to reintroduce Targeted Long-Term Refinancing Operations (TLTROs).

On the macro front, global markets enjoyed a marked recovery over the quarter following a difficult end to 2018. There were positive returns across almost every asset class as investors were buoyed by geopolitical developments and dovish central banks, which outweighed lingering concerns over a slowdown in global GDP growth.

Several of the issues that dogged sentiment last year saw signs of progress, with developments in the US-China trade dispute resulting in a decision to delay higher tariffs on Chinese goods.

Brexit continued to dominate headlines in the UK however, as the originally scheduled deadline of 29 March passed without resolution. Prime Minister Theresa May saw her withdrawal agreement rejected three times, continuing the stalemate despite garnering the support of some of the more outspoken Brexiteers in the most recent vote. Overall, the situation remains fluid and difficult to predict – with an extension now pushed out until October – but investors appear to have taken the diminishing likelihood of a no deal scenario as positive.

While political developments were generally encouraging over the quarter, economic data remained mixed and, as stated, concerns are growing about the apparent slowdown in growth. Data has been particularly weak across the eurozone, nowhere more so than in Italy, which slipped into technical recession following two successive quarters of negative economic growth. Germany was a further cause for concern, producing zero GDP growth and demonstrating continued weakness in Purchasing Managers Index (PMI) levels.

In response, the ECB appeased investors by taking a more dovish stance, keeping rates on hold and announcing there will be no rises until at least 2020, having previously only ruled out the possibility until this summer. As outlined, the Bank also announced the reintroduction of TLTROs to address concerns over the impact on the banking sector of an extended period of negative interest rates.

Continued economic weakness in the US drove a turnaround in commentary from the Federal Reserve, which also grew increasingly dovish over the period. Chair Jerome Powell stated the Bank has the "luxury of patience" in deciding whether to raise rates again, pointing in particular to sluggish inflation. Its decision to keep rates on hold resulted in the first quarter without a hike since Q3 2017, with the Fed dot plot now indicating no expectations of any rises this year. The Fed also revealed plans to stop its balance sheet reduction program earlier than expected in September and a downward revision in economic forecasts.

Meanwhile, despite UK data being generally positive, the Bank of England also continued to keep rates on hold as Brexit uncertainty continues to outweigh the underlying strength in the economy.

Against this backdrop, there was modest portfolio activity. Corporates took advantage of market conditions: new issuance was relatively high over the period and better absorbed by the market than initially anticipated, with premiums narrowing significantly as a result. We also took advantage, participating in some of these new issues at attractive valuations.

We established a position in Swiss Re, which provides reinsurance and insurance services. The company is industry leading in terms of integrating sustainability research and analysis, not only into its investment process, but also underwriting practices. The new issue offered an attractive opportunity to gain exposure to a high-quality issuer, rated AA- at the senior level, with high levels of solvency. This was funded by exiting positions in Aegon and Zurich.

We also reduced exposure to the banks sector following recent strong performance, as a number of the bonds we held appeared fully valued, resulting in the disposals of Swedbank, KBC and HSBC from the portfolio. We invested the proceeds into non-financials where we see greater value on offer, adding exposure to telecommunications and utilities as well as initiating a position in Intercontinental Hotels Group.

Over the quarter, we maintained the Fund’s duration position at two years short relative to the benchmark, 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. This is expressed solely through the German market, as Bunds appear particularly overvalued with 10-year yields having fallen below 0%.

Looking to the rest of the year, we believe the macro backdrop for credit markets remains positive, supported by solid economic growth, low default rates, loose monetary policy and positive trends in corporate earnings. While corporate bond valuations have recovered significantly from the lows seen in Q4 2018, we see scope for further improvements as technical and sentiment concerns subside, shifting market focus back to the relatively strong underlying macroeconomic and corporate fundamentals.

Our core sector preferences within insurance and telecoms are supported by attractive valuations and higher credit quality and remain unchanged over the longer term.

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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.

Wednesday, April 24, 2019, 4:01 PM