Liontrust GF Strategic Bond Fund

November 2018 review

Last month we discussed the growth scare that the financial markets had experienced and the contagion felt across financial assets from a repricing of risk premia. In November that contagion spread to physical assets with the oil price getting caught in the crosshairs; Brent fell over 20% from US$75.4 to US$58.7. Supply had been ballooning so an oil price fall is not exclusively an indicator of lower aggregate demand. Oil has both relatively inelastic supply and demand so we should expect large moves in its price; one needs to either entice extra supply or, in this case, reprice to where the marginal producer becomes unprofitable. In the longer term though, a decline in oil prices is positive for demand as energy costs absorb less share of consumers’ wallets.

 

November was shaping up to be another turgid experience for most assets, albeit late in the month the US monetary policy narrative shifted and the stage has now been set for a potential relief rally. Jerome Powell, Chairman of the Federal Reserve, pointed out that US interest rates are approaching their neutral level and that the impact of monetary policy has a natural lag. Changes in interest rates in 2019 will be far more dependent on prevailing economic data than the quarterly 25 basis point increases we have witnessed this year. We expect the FOMC 18-19 December 2018 meeting to culminate in a rate rise, but the outlook becomes more opaque after that. Financial markets have now shifted to pricing in only one rate rise in 2019. Our central case scenario is more hawkish as we believe that rates will go up in the first two quarters and then pause. It should be borne in mind that even when interest rate rises are put on hold, US monetary policy will still be becoming more restrictive due to the monthly US$50bn of quantitative tightening.

 

The one certainty is that, as we approach the latter stages of the cycle, uncertainty will be higher! This means that elevated volatility levels are here to stay. As active managers we welcome this as it should throw up a large number of investment opportunities. Highlights of November’s activity are split out below by our three alpha categories.

Rates


The Fund’s underlying adjusted duration
is little changed compared to the end of October at 3.0 years; but like the metaphorical swan’s feet paddling hard below the water this headline number masks activity undertaken in the interim. Early in November we added half a year to Fund duration before locking in the profits on this after a rates rally. We also implemented and successfully closed a cross market position being long New Zealand government bonds versus short Japanese government bond futures (as a reminder, we hedge any currency risk in the Fund). New Zealand government bonds had sold off due to strong employment data and, rather than adding duration risk outright, we paired this with the lower beta Japanese market; a rapid reversion occurred which generated a little extra alpha for the Fund.

 

Allocation


A couple of months ago the Fund had a 10% net weighting in high yield, with 20% in physical stocks and a 10% risk reducing CDS index overlay. Fast forward to the end of November and the gross weighting remains very similar but the Fund is now 10% long risk using the CDX HY index leaving a net 30% position.  Value has returned with US high yield prices below par and yields above 7%.  This is partly due to the fears of a repeat of the 2014-15 energy crisis and its impact on the US high yield market; however there has already been a cleansing of the investment universe and many aggressive capital structures defaulted in that cycle.  To be clear we do not need a turn in the oil price for US high yield to outperform, just a stabilisation as the supply/demand imbalance corrects itself.  Energy related issuers represent only 10% of the CDX HY index with the other 90% contributing to the 100 basis point widening due to a contagion effect.

 

Selection


Staying with the high yield theme, profits were taken in Getsamp early in November. Toward the end of the month a new investment in United Rentals, the leading equipment rental company in the US, was established.  United Rentals is undoubtedly cyclical but has many levers it can pull, such as spending less on fleet renewal, which enables it to ride out downturns. The Fund also bought back into Telecom Italia over 10 points below where we had previously sold it. 

 

Within the investment grade arena, the focus for many people over the month was GE as its corporate bond spreads came under huge pressure due to fundamental challenges coupled with an accompanying downgrade.  The Fund owns no GE and it is rare for us to feel compelled to comment on bonds that the Fund has no exposure to, however GE is such a large issuer that its troubles have helped set a negative tone throughout the market.  Additionally a jumbo new primary issue from VW was priced significantly wider than secondary market trading levels which caused a reappraisal of the clearing price for credit risk. With dispersion in spreads increasing, the Fund did suffer from spread widening in BAT’s bonds due to the risk of the US banning menthol cigarettes; this would be detrimental for BAT but not an existential threat so we have retained exposure to the name. Our preference was to add to high yield in the weakness but we did also top up a couple of investment grade issuers’ bonds including EDF (the French utility) and Aroundtown, a German property company who had another stellar set of quarterly results.

 

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.
Thursday, December 6, 2018, 3:37 PM