Liontrust Strategic Bond Fund

August 2019 review

The Liontrust Strategic Bond Fund returned 0.7%* in sterling terms in August, compared with the 0.9% average return from the IA Sterling Strategic Bond sector.

 

Market backdrop


Financial markets in August tend to have much lower volumes and are therefore subject to some erratic moves. This year these were further exacerbated by the continued trade wars, manifesting as both tariff implementation and de facto competitive currency devaluations. I simply cannot fathom how having US$17 trillion of debt with negative yields can be a healthy thing for the global economy. Resistance to central banks prescribing more of the same ineffective monetary policy medicine is certainly growing. To repeat a point we raised in our last monthly fund commentary, global inflation is running at about 1.9%; an environment that does not justify such extreme sovereign bond market conditions.

One important market development during August is the inversion of the 2s10s US yield curve, i.e. 10 year US Treasuries now yield less than the shorter tenor 2 year ones. This has historically been a strong indicator of an impending US recession within the next 12 to 18 months, although it has sent out some false signals too.

Liontrust Strategic Bond Fund August 2019 review

Source: Liontrust, Bloomberg

In this case I don’t believe the yield curve is telling us anything we don’t already know.  There has been a huge slowdown in industrial production driven by the protectionist actions of politicians. So far there has been limited contagion to services and consumer sentiment, employment remains resilient and central banks are reacting to the threat of cross sector contamination ahead of it actually occurring. As we approach the next US presidential electoral cycle in 2020, one should expect more of an effort to boost the economy, the traditional way for an incumbent to achieve re-election. One thing is for certain: the bond market is not priced for any resolution of the trade disputes.

In Europe political matters are also front and centre. In Italy, Salvini withdrew Northern League support from the coalition government seeking to force an election and capitalise on their recent polling and strong showing at the EU elections. This looks to have backfired as the 5 Star Movement and PD (Democratic Party) are close to consummating a new coalition and the Northern League has fallen back in the polls. With 10 year Italian government bond yields comfortably below 1%, the market clearly craves political stability. 

UK gilt yields continue their seeming inexorable journey towards zero yield. The barometer for investor sentiment around the UK political situation is the UK currency which at the time of writing is flirting with 1.20 versus the US Dollar. The situation is very fluid and our central case remains that a general election is called; all of Boris Johnson’s bluster over the last few weeks needs to be seen in the context of trying to coax Brexit Party supporters back to the Tories and artificially pit the people versus parliament.

On the political front spare a thought for Argentina where Macri appears on his way out, to be replaced by Fernandez. This has already led to an attempted “re-profiling” of domestic Argentine debt and an international debt default is inevitable in the next month or two. Fortunately, we held zero emerging market risk in the Fund; regretfully we were not short risk using the CDX EM index.

Returning from the political sphere to the economic one, we still believe that real growth will be reasonable, and nominal growth strong, driven by the consumer and service sectors. We are therefore bearish on fixed income as there is too much priced into the markets for the central banking “put” and not enough for trend-like inflation. We have taken the Fund’s duration down to the 2 years area, retaining some correlation to the rates markets but reducing interest rate risk further. In years to come, economic historians will look back on this time as a period of immense central banking market manipulation coupled with investors relying on the greater fool theory; we’d rather be risk averse on rates than be on the wrong side of the eventual turn.

Rates

The US Treasury market was remarkably strong in August, TIPS (Treasury Inflation protected Securities) didn’t keep pace, i.e. inflation breakevens tightened, but they still produced a decent positive total return for the month. We reduced some of the conventional duration in the US; it is still our preferred rates market but it is prudent to lock in some profits. On the other side we purchased a little duration exposure in the lower beta German and Japanese sovereign bond markets. 

 

The Fund’s French versus German 10s30s box trade (long the French/German 30 year spread and short the 10 year spread) saw both legs generate a small profit. We closed out the position at the end of August having made approximately 5 basis points of alpha for the Fund.

 

Allocation


With the wonderful alliteration that is the Trump tariff tweets causing some turbulence during August, we started to add to high yield in the Fund. We consider a 20% weighting to be neutral and have been running nearer 10% in physical bonds in the last few months awaiting a better entry point. Credit default swap indices weakened more than physical bonds so it was efficient to increase risk using them. We bought US exposure through the CDX HY index and European high yield risk using iTraxx Xover. The latter rallied strongly and we banked profits towards the end of August. We’d love to see a more significant shakeout in order to add to the high yield exposure in the Fund.

Selection

In thin August markets, stock level activity was low. A new position was purchased in UPC bonds where the underlying cable business is strong and there is potential upside if a merger with Sunrise goes through. We expect activity to increase in September as an erumpent primary market generates potential new opportunities and distracts some investors from relative value in secondary markets.  

 

Discrete 12 month performance to last quarter end (%)**:

 

Jun-19

Liontrust Strategic Bond B Acc

5.5

IA Sterling Strategic Bond sector average

5.3

Quartile

2

 

*Source: Financial Express, as at 31.08.2019, accumulation B share class, total return (net of fees and income reinvested.


**Source: Financial Express, as at 30.06.2019, accumulation B share class, total return (net of fees and income reinvested.
Discrete data is not available for five full 12 month periods due to the launch date of the portfolio.

 

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. 


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, September 6, 2019, 12:00 PM