Liontrust GF Strategic Bond Fund

December 2018 review

December continued the growth scare theme that had been prevalent throughout the last quarter of 2018.  Fears about trade and tariff wars have held back corporate investment and enhanced market nervousness. The oil price has slid further with WTI and Brent straddling either side of US$50 a barrel respectively; we view this fall as a longer-term positive tailwind for growth as energy costs take up a smaller share of the consumer wallet. There are other stabilisers that also significantly impact the growth outlook, including inflation-targeting monetary policy that has the effect of offsetting some of the fiscal boost in the US. This common sense approach has been much to President Trump's chagrin and he sent markets into a tailspin when he intimated he would fire Federal Reserve Chairman Powell.  Any threats to central bank independence are frowned upon by markets in modern fiat economies. The fact that interest rate decisions are made by a committee following a specific mandate seems to have been lost on the "leader of the free world”.

 

In line with market expectations, the Fed increased its rates range by 25 basis points in December. The FOMC voting members' dot plots were revised down and their forecasts are now for two rate rises in 2019; a number that also represents our most probable scenario. However, the markets have now priced out any US rate rises in 2019; an act which we believe is premature. There has been increased focus on the US yield curve (specifically the 10 year yield minus the 2 year yield), which is seen as a strong indicator of a future recession if it inverts. I have long argued that an inverted curve signals a monetary policy overshoot and I maintain that it is still a strong signal. But I caution against blind reliance upon any one indicator as the yield curve has predicted nine of the last six recessions. We have written more broadly on the 2019 outlook should you desire more detail.

 

On the fiscal front the US government, at time of writing, is in partial shutdown as the relevant budgets have not been signed off. The impasse surrounds the Democrats refusing to fund President Trump’s wall on the Mexican border; the situation could be resolved relatively easily if, for example, the wall is traded off for more border patrols. However, all of this is just a warm up for what could be a full US Government shutdown in around August of this year when the next debt ceiling limit is likely to be reached. On a much more positive note the Italian government finally signed off its 2019 budget with a projected 2.04% fiscal deficit.  The problems of low Italian growth and the need for structural reforms will not go away but this provides a few months’ breathing space; to be clear, we are still not tempted to buy the sovereign debt though.

 

As the flight to quality trade amplified, developed market government bond valuations have become far too stretched; therefore we have reduced duration in the Fund. On the other side of the coin, credit is now discounting a large amount of bad news and we have added exposure, with a preference for high yield over investment grade. 

 

Rates

The largest change to the risk profile of the Fund during December was a reduction in underlying adjusted duration to just below 2 years. The majority of this reduction was in the US, split across both the 5 and 10 year tenors. As mentioned above, bond markets have become far too bearish about the economy; growth will be slower in 2019 but anticipated global real growth of 3% is still reasonable plus there is increasing wage inflation pressures too.  Absent any new news, if developed market government bond markets rally further we will reduce duration more; conversely if yields increase as anticipated we will add back some interest rate risk to the Fund.

 

Allocation

As well as running a low interest rate beta, the Fund has also been running a low credit beta. We added a little to the investment grade credit weighting in the Fund, taking it from 30% to 33% during December; we would have added more but liquidity was poor. We have been increasing exposure in the early stages of January. Our preference remains for taking high yield risk over that of investment grade partly because of valuations but mainly due to a better technical backdrop with the supply/demand imbalance and current investor positioning causing far greater pain in the higher grade markets. 

 

A new relative value trade was implemented during December as a result of the spread differential between emerging market hard currency sovereign debt and US dollar high yield becoming far too wide. Both asset classes perform better during times of “risk on,” are correlated to global growth and have some energy exposure. Yet whilst high yield has sold off, emerging market debt has been steadfast.  We have therefore gone long risk high yield versus an offsetting short in emerging markets, both legs using liquid credit default swap indices. We have implemented the relative value trade in an approximately 1:2 ratio to account for the different betas of the respective two indices.

Selection

The investment grade credit that we were adding to very much constitutes household names. Examples included Vodafone, Goldman Sachs, Vinci, Innogy and Wells Fargo; at the margin more was purchased in euro-denominated bonds, but as liquidity returns in January we expect to increase US dollar holdings by a greater amount. In high yield we took a little profit on Netflix, which rallied strongly on one of the positive days for risk.  The proceeds were recycled into Neptune Energy, which is a lowly leveraged predominately gas company that is run by a highly experienced management team.

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. 

 

The Liontrust GF Strategic Bond Fund was launched in April 2018. As its track record is less than one year, regulatory restrictions prevent presentation of performance data in this report.

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. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.

 

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.

Tuesday, January 15, 2019, 4:36 PM