Liontrust Monthly Income Bond Fund

Q3 2019 review

The Fund returned 1.9% over the quarter, lagging the IA Sterling Corporate Bond sector average of 3.1% and the iBoxx Sterling Corporates 5-15 Years Index’s 3.4%*. 

 

The period proved one of contrasting fortunes. Overall, the summer months saw a significant sell-off in bonds, as a combination of escalating US-China trade tensions, deteriorating global economic growth, and heightened Brexit uncertainty saw markets adopt a risk-off tone. The changing seasons brought a change in investor attitudes however and further monetary stimulus from central banks boosted investor confidence in September, with risk assets rebounding strongly.

Despite a sharp sell-off in September on the back of this central bank activity, the Fund’s underperformance was predominantly driven by the marked fall in Government bond yields over the full quarter as investors grew increasingly concerned by the macro backdrop. UK 10-year Gilt yields fell 35 basis points to finish the period at 0.48%, having set a new all-time low of 0.40% during the quarter. German 10-year Bund yields also continued to set records, dipping as low as -0.72%, before rallying to finish the period at -0.58%. US 10-year Treasury yields fared little better, falling 34bps to reach 1.67%.

Although our underweight duration position was a negative contributor, we did benefit from managing it actively. The decision to maintain a sizeable portion of the position via the German market, where yields did not fall as sharply as the US and the UK, proved positive, as did rotating some of the short out of the UK and into the US during August, as the sharp rise in US yields in September outstripped the UK.

The negative impact of our duration position was somewhat offset by the overweight in credit, as corporate bonds outperformed government bonds over the period. This was predominantly driven by a combination of both sector allocation and stock selection, particularly within our largest sector weightings to utilities, insurance, banks and telecommunications.

We saw a positive contribution from longer spread duration holdings, as names such as AT&T and Yorkshire Water benefitted from falling government bond yields. Also positive were higher beta subordinated positions, in names including Standard Chartered and SCOR, as credit spreads tightened further over the period.

Our overweight in the Mortgage Backed Security (MBS) sector detracted over the period, specifically Intu. The company reported disappointing results and a worse-than-expected deterioration in the valuation of its shopping centres, which, combined with more retailers filing for CVAs and anticipated pressure on future rental agreements, has created a challenging backdrop. Intu needs to refinance its near-term debt maturities but the lack of retail property transactions and difficult market conditions means this will be challenging. Given these factors, we elected to dispose of our holding.

As stated, Q3 was a busy period on the policy front, with two rate cuts from the Federal Reserve and the European Central Bank also reducing rates and committing to open-ended quantitative easing from November.

The Fed’s first cut in 11 years was back in July but the 0.25% reduction was actually less dovish than anticipated, with some investors expecting a 50bps cut and Chair Jerome Powell emphasising this would not be the first of many. In fact, continued weakness in economic data and ongoing pressure from President Trump saw another 25 basis point cut just two months later: again however, while widely anticipated by the market, the associated commentary was more hawkish than expected. Growing divisions appear to be emerging within the Federal Open Market Committee itself. While seven of the 10 FOMC members voted for the September cut, two dissenters argued not to cut at all and one called for a 50-basis-point reduction. Such disagreement is unusual and make it difficult for Fed-watchers trying to predict which way policy will go.

Moving across the Atlantic, the European Central Bank opted not to cut rates in July but announced a stimulus package to come in September. This dovish stance was reinforced by the nomination of Christine Lagarde to take over the ECB presidency from Mario Draghi in November.

As widely predicted, the ECB cut its deposit rate to a record low -0.5% from -0.4% in September and pledged to restart bond purchases of 20 billion euros a month from November. While this was lower than market expectations of around €40 billion, the programme was left open ended and is set to continue until the bank has achieved its inflation target. ECB president Mario Draghi also implored European economies to provide additional fiscal stimulus in order to further support growth.

Coming finally to the UK, Brexit continues to dominate and we saw Boris Johnson secure a comfortable victory in the Conservative leadership race in July to become Prime Minister. The result renewed concerns of a no-deal, as he pledged to ensure the UK leaves the EU with or without a deal by the 31 October deadline.

Adding to the controversy, Johnson announced plans to prorogue Parliament, with the intention to shut down for an unprecedented five weeks and reconvene following a Queen's speech on 14 October. This was widely seen as an attempt to stall anti-Brexit activity and, in September, the Supreme Court ruled prorogation unlawful and MPs were called back with immediate effect. 

Meanwhile, the back and forth continues: Johnson continues to meet European leaders while reiterating his message on leaving come what may on 31 October but to prevent a no-deal, Parliament has passed legislation forcing him to ask for a further extension if there is nothing in place by 19 October. Amid all this, the Bank of England kept rates on hold over the quarter, saying that the ‘entrenched uncertainty’ caused by Brexit and trade will keep rates lower for longer and could prompt a cut in short order.

Given the political uncertainty engulfing the UK, it is easy to overlook the rising political uncertainty elsewhere. In the US, there are increasing calls for impeachment proceedings against Trump concerning alleged contact with Ukraine regarding former Vice-President and prospective 2020 Democratic Party presidential candidate Joe Biden. In continental Europe meanwhile, Italy’s coalition government collapsed, with a seemingly equally replacement formed between the Five Star and Democratic Parties.

Against this backdrop, there was modest portfolio activity over the period.

New issuance was relatively muted over the summer months, before volumes picked up again in September. The Fund took advantage of a new issue from Nationwide Building Society, increasing our existing exposure. The new issue offered an attractive entry point to a company we continue to hold in high regard due to its prudent lending practices, leading to low loan to value and extremely high levels of capital. This was partially funded by rotating out of our existing position in Nationwide USD bonds, as we believe the new sterling issue offered greater relative value.

Alongside the Intu disposal, we also sold our holding in Virgin Media. The potential for M&A in order to add scale to Virgin Media’s mobile business has increased significantly, with parent company Liberty Global flush with cash following the sale of its central and eastern European assets to Vodafone earlier this year. Combined with the well-known availability of some UK mobile assets, and strong performance delivered by the bonds year to date, we viewed the risk-return trade-off as no longer attractive and exited our position.

Against this, we added a new position in Dwr Cymru (Welsh Water). The company boasts strong credit metrics, resulting in it being the highest rated water utility in the sector, and is further supported by its not-for-profit ownership structure, making it resilient to the threat of potential nationalisation. The business is seeing consistent improvements its operating performance and retains sufficient levers to pull should the upcoming new pricing regime be less favourable than the current regime.

There were also several of relative value switches over the quarter, particularly within the insurance sector. While we continue to believe the sector looks attractive from a valuation perspective, we elected to reduce our overall risk exposure following strong performance year to date. This was achieved through reducing the spread duration by shortening the bond maturities held, with the main examples being Aviva and Legal & General.

We maintained the portfolio’s duration position at five years short relative to the index over the period but, as stated, managed the market allocation actively throughout. In August, we decided to rotate 0.75 years of our short position from the UK into the US, driven by a combination of volatility in the wake of Boris Johnson’s appointment as Prime Minister and the inversion in the US yield curve as two-year Treasury yields rose above ten-year. This is widely believed to be a leading indicator of a recessionary environment but we continue to believe the risk of a US-led recession is low and hence the moves in the yield curve were unjustified.

Following a spike higher in US Treasury yields in September, and Brexit developments we believe moved the UK further away from a no-deal scenario, we opted to rotate 0.5 years of the short back into the UK from the US. This leaves the portfolio’s duration position expressed via a two years short position to the German Market, 0.5 years short to the US and 2.5 years short to the UK.

Looking forward, we remain firm in our belief that the macro backdrop for credit markets remains supportive. Notwithstanding the ongoing weakness in the global economy, we see three key factors that reinforce our belief.

First, despite the warning lights, the risk of a global and US recession is low. The service sector, the largest component of developed economies, remains strong, bolstered by low unemployment, positive real wages and robust housing markets.

Second, central banks continue to be supportive, with the US Federal Reserve cutting rates for the first time since 2008, and the ECB announcing a fresh stimulus package. Finally, corporate credit fundamentals remain relatively strong, particularly within investment grade, typified by high interest coverage ratios, stable net leverage ratios and low levels of defaults.

We also continue to believe government bonds are overvalued and expect yields to rise as macro concerns abate, although volatility is likely to persist over the short-term as Brexit uncertainty and trade war concerns remain. As such, we retain an underweight position to interest rate risk, spread across the UK, Germany and the US, and will continue to actively manage this allocation.

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

 

 

Sep-19

Sep-18

Sep-17

Sep-16

Sep-15

Liontrust Monthly Income Bond B Gr Inc

5.0

0.8

6.7

10.6

2.2

iBoxx Sterling Corporates 5-15 Years Index

10.9

0.2

1.2

14.1

4.9

IA Sterling Corporate Bond sector average

9.0

0.1

0.6

12.2

2.8

Quartile

4

1

1

3

3

 

*Source: Financial Express, as at 30.09.19, 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, October 21, 2019, 11:31 AM