Liontrust GF Strategic Bond Fund

January 2019 review

It was a great month for risk assets, with a final boost given by a dovish Federal Reserve on the 30th (for more thoughts on this, please read our blog ‘Are we nearly there yet’ ). The initial trigger for bullishness was strong non-farm payroll employment statistics on 4 January.  These were a timely reminder that economic growth is still alive and well. The growth scare of the last quarter of 2018 continues to permeate through the market and there have been downward revisions to this year’s global growth forecasts to around 2.9%.  However, one needs to bear in mind that all we are doing is going from above-trend growth in 2018, caused by a late cycle fiscal stimulus, to a payback of slightly below trend in 2019. 

Production numbers have undoubtedly been weaker than expectations, partly driven by the ongoing trade and tariff tensions. The current mood music about a trade deal between the US and China seems to be positive, but that could easily be ruined by one rogue tweet. One should also note that the Fed has been gradually tightening monetary policy, albeit from loose to neutral, for over three years now which will have pared back some economic activity. Overall though, the US economy still retains reasonable momentum and employment continues to strongly increase. This feeds directly through into the key constituent of growth, namely consumption which represents approximately 70% of US GDP. A combination of employment growing, wages increasing by over 3% and population growth lead to the conclusion that consumption will add over 2% to US real GDP growth rates this year. This does not look out of kilter with the rate of the last decade post the financial crisis. The mix will also change with lower energy prices taking up a smaller proportion of the proverbial consumer's wallet, freeing up cash to spend on other less essential items.

 

Government spending will have a lower impact on US growth in 2019, partly as a result of the fading impulse effect of the stimulus in 2018. With Congress now divided, budgetary decisions become much harder to pass.  December and January saw a partial Federal shutdown as the Democrats refuse to sign off on spending for Trump's border wall. As a guide, in previous occurrences the impact was about 0.1% off GDP for every week or two of shutdown. The longer the shutdown goes on, the more severe the impact will be; furloughed employees burn through their savings and second order impacts of the shutdown kick in, such as contractors not being paid and not being able to pay their staff. The budgetary reprieve lasting until 15 February buys time to reach a compromise, but there remains the risk that political intransigence will happen again. A far bigger risk occurs in when the US is likely to be hitting its debt ceiling again – likely to be around August his year – which could lead to a much larger-scale shutdown.

 

On the subject of political intransigence, the Brexit farce continues to dominate headlines on the small group of islands called the UK.   Meanwhile, weaker economic data from continental Europe has been met with the usual soothing language by Mario Draghi, another topic we have blogged on – Where is the emergency.

Rates

The yield on US 10 year bonds finished the month unchanged, whilst German Bunds continued a seemingly inexorable grind towards zero yield. During some intra-month weakness in rates we added half a year’s duration back to the Fund, finishing January at a little over 2 years; an exposure that is still light compared to our midpoint of 4.5 years and way below 7 years of the index. Post the Fed’s capitulation we have adjusted the Fund’s yield curve position by selling 30 year US futures and investing the equivalent duration amount in the 10 year. This is part of a theme of the Fed being too worried about growth and too sanguine on inflation. Another way that theme is manifesting itself in the Fund is through a long position in US inflation breakevens, preferring investment in TIPS (Treasury Inflation-Protected Securities) to conventional bonds. Breakevens performed strongly in January, rebounding from end-2018 oversold levels; we think there is still much further to go with the 10 year level of 1.8% below the Fed’s 2.0% inflation target.

Allocation

The Fund added to some investment grade holdings on 3 January, the first day of the year with any decent credit market liquidity. It was one of those very pleasing days when trade execution goes your way; our central dealers were asking brokers for prices and receiving offers near the bid side of the market, but then on numerous occasions a rogue price much lower than all the others would arise as whichever broker in question was looking to reduce their trading book risk. Frequently one gets rewarded for being a contrarian in credit. By the end of January spreads had tightened significantly and we took some profits, finishing with 31% in investment grade.

The global high yield market had its third best January ever! Having increased the Fund’s weighting to 30%, compared to a 40% maximum, we captured the majority of this move to the benefit of the Fund. Valuations are now no longer as compelling so we have taken profits on the CDX HY index overlay. This leaves an 17% weighting to high yield all in our favoured stock picks; note we also have a relative value asset allocation position long high yield using CDX HY versus short hard currency emerging market sovereigns (CDX EM) which is beta neutral and not included in that total.

Selection

Examples of names that were added to in early January included BATS, Verizon, Citigroup and Bank of America.  By the end of the month the subordinated bonds purchased in Citigroup had rallied over 7 points, so we took profits and exited the position.

The Fund undertook a switch within subordinated financials, selling some bonds issued by Zurich Insurance that had rallied strongly in January.  On the purchasing side a position was established at 94.5c in Prudential plc dollar bonds which can be called at par once a quarter; we do not expect the Pru to imminently retire this capital instrument but would expect some resolution in the next few years.

Within high yield the Fund switched long dated Telecom Italia dollar bonds into an attractively priced new 5 year issue in euros.  Profits were taken in United Rentals, a US plant hire company that we really like but everything has its price.  A tender was announced for some Softbank bonds, we did not participate but did trim a little over 1 point higher after the tender.

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.

Friday, February 8, 2019, 3:23 PM