Liontrust Monthly Income Bond Fund

Q2 2019 review

The Fund returned 1.8% over the quarter, lagging the IA Sterling Corporate Bond sector average of 2.3% and the iBoxx Sterling Corporates 5-15 Years Index’s 2.5%*. 

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.

Overall, the fund’s short duration position was the primary driver of underperformance as developed market government 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, 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.

This negative effect was partially offset by our overweight in credit, as corporate bonds outperformed government over the period. Sector allocation and stock selection both contributed positively to returns, particularly core overweights to insurance and telecommunications as some of our higher-beta subordinated bonds and USD-denominated debt performed strongly.

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. Following a generous liability management exercise conducted by Prudential, we decided to exit one of the bonds held, rotating the proceeds into Assicurazioni Generali debt offering greater value. We also switched out of BNP Paribas, which had performed very strongly, into similarly highly rated Coventry Building Society where we see better value at current levels.

Elsewhere, we completed a couple of cross currency switches in some established issuers within the portfolio such as BT and GlaxoSmithKline. We switched out of sterling and 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.

Other moves included exiting our position in Tesco following an attractive tender offer, opting to reinvest the proceeds across a number of other names within the portfolio. We believe the company’s remaining bonds outstanding are fully valued, with markets having already priced in a return to investment grade.

We also initiated a position in Telefonica, as the bonds were trading at an attractive discount relative to comparable telecommunication peers. The company’s credit profile is supported by its well-diversified business profile, strong positioning in its core markets, prominent infrastructure assets with the leading fibre footprint in Europe and Latin America, and management’s ongoing commitment to deleveraging.

Another new position is Pension Insurance Corporation, an operator in the bulk purchase annuities (BPA) market with a leading market share. The company is prudently run with 92% fixed income investment, of which over 95% is investment grade, a healthy solvency two position, and limited exposure to market sensitivities. Operationally, it is delivering good growth from the underlying book, which is set to continue to expand as the market remains relatively untapped.

Meanwhile, we exited our position in Society of Lloyds following a review of its sustainability criteria, which resulted in a downgrade to B5, making the name no longer investable. The downgrade stemmed from an ongoing internal investigation into various claims of sexual misconduct.

We continue to believe government bonds are overvalued and expect yields to rise as concerns over a no deal Brexit and trade wars abate. As such, we maintained the fund’s duration position at five years short relative to its benchmark, currently expressed through a 2.75 year short to the UK, a 2-year short position to the German market and a 0.25 year short to the US.

During the period, we maintained the short to the German market, where we see the most value after yields reached all-time lows. We also re-established a short to the US following a significant repricing in Treasury yields, expressing the position via the two-year part of the curve where we see the greatest opportunity given the current inversion, with two-year yields moving higher than five-year.

Against this, we reduced our short position to the UK slightly amid heightened political uncertainty in the short term, although we continue to believe a no-deal Brexit scenario is unlikely.

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

 

 

Jun-19

Jun-18

Jun-17

Jun-16

Jun-15

Liontrust Monthly Income Bond B Gr Inc

4.0

0.1

14.4

3.2

2.8

iBoxx Sterling Corporates 5-15 years Index

7.1

0.7

7.1

8.6

6.4

IA Sterling Corporate Bond sector average

5.6

0.6

6.4

6.1

4.3

Quartile

4

4

1

4

4

 

*Source: Financial Express, as at 30.06.19, primary share class, total return, net of fees and interest reinvested.

 

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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, 2:35 PM