Liontrust Strategic Bond Fund

February 2019 review

After the madness of December and January, February provided a return to more sane asset price movements. True, markets in general performed positively most of the time and volatility was much reduced. Muted moves reflected global market levels now closer to fair value.

 

The engines driving price appreciation in most assets – easier central bank policy, trade and tariff optimism - continued to turn. The lack of further acceleration perhaps reflects that most of the fuel had been spent in the first month of the year.

 

I’m not one for running through each historic data point. Broadly, I believe G7 macro numbers continued to reflect the bifurcation of consumption from production. Very low unemployment and a recent surge in average earnings series have left the consumer in a position of strength. Most macro data focussed on this part of the economy have proven resilient.

 

At the same time, there is no hiding from the fact that investment and production have been worrying and in core European markets deeply so. There is some small sign that forward looking numbers are a little better.

 

This pattern of resilient consumption and fading production is classically end of cycle. It fits very well with our expectation from 2018 that President Trump’s tax cuts would have a short lived effect on US and global GDP. A slow down into 2019 was always likely. The question for us: does this slowdown turn into something more severe?

 

For consumption to hold up, we need the employment picture to remain good. For that to happen corporates need to start spending, either boosting production or investment. Personally, I’d prefer the latter. I continue to believe that one of the negative legacies of quantitative easing has been a lack of investment, broadly reflected in economic data. Why invest when demand remains robust and your stock price benefits from the rising market? This is much more of an issue for Europe it seems. The impact of negative sentiment from both an easterly and westerly direction has seen even the exporting power house of Germany turn sluggish. A reduction in tariff tensions between the US and China and subsequent clarification of the position of European automotive exports could see German data rebound strongly. Whilst this may not do much for the other end of the European economy spectrum, it may be enough to force the ECB to deliver on rate rises toward year end.

 

If I were to sum up the past 12 weeks in three points:

  1. Central banks globally turned more dovish in response to market (and macro?) data. So, “poor” data suddenly seemed “good” helping prevent further rate rises and support asset prices.
  2. China and the US seemed to move from enemies to friends. If the tariff situation is sorted then we can probably add 0.5% or so back to global GDP; in other words 2019 looks like another “trend” year.
  3. European politics took a turn for the better – Italy avoided a downgrade from Fitch and the UK Brexit situation seems set to be pushed back reducing the risk of a no deal exit.

And an outlook for the next 12 weeks? Position for the three points above correctly and I suspect you will be on the right side of most market moves!

 

Rates


We moved Fund level duration around in a range of 2 to 2.5 years
. At all times we remained well below our neutral level of 4.5 years (and of course way below the 7 years of the global aggregate index). More dovish central banks may be positive for risk assets but in the longer term they make inflation more likely. As such, terminal rates may end up higher than previously thought though this all depends on incoming growth and inflation, something we agree with the Fed about.

 

Markets did rally a little following what appeared to us quasi co-ordinated dovish talk from central banks around the world. To reiterate, production softened as trade tensions rose in 2018. Risk markets fell and we are really nervous central banks reacted to this too much (or rather that investors are reading more into words than they should). The recovery in risk and improvement in trade talks could make for a volatile combination.

 

No one is talking about US interest rate hikes. If the Fed fails to raise and inflation picks up there is a very good chance we see US yields back above 3% by the end of Q2 – remember when I said that would happen a year ago most people thought me mad.

 

Anyway, we see little point in adding really expensive risk here. Our other core positions remain:

  1. We remain light duration against our (and market) “neutral” levels
  2. We prefer (as opposed to like) the US to Europe on a relative value basis
  3. We want to “short” European markets but can’t yet oppose the strong technical deman 

Allocation


Having added risk in a weak December as markets moved to price recession, we sold in January into one of the biggest credit market bounces seen in 20 years. Indeed we have actually overshot fair value. Folk seem to believe all that damaged the world now makes it better.

 

For sovereign debt we put on a “curve steepener” in the US – expecting 30 year bonds to do worse than 5 and 10 year maturities. Our view: If the Fed is truly on hold and taking a risk with inflation then long-dated bonds will come under a lot of pressure. Plus, they are expensive and everyone else has the opposite view.

 

Further trimming high yield stock specifics took the combined high yield and emerging market weight to a little under 15%. It is unlikely we will go much lower than this, unless of course the market really thinks the goldilocks scenario is returning and takes high yield another 3-5% higher in capital terms.

 

We didn’t really do much with our investment grade weight. We are still significantly underweight, at around 38% of the Fund relative to our long run 50%. Investment grade is a little expensive and although we are not worried about the level of BBB bonds in the market, we recognise the negative impact this could have on sentiment. A perfect example was Kraft Heinz – which we don’t own and we don’t expect their BBB bonds to be junked soon – where bonds fell materially in price and affected the broader market a touch.

 

Selection

It was a somewhat quieter month for stock selection. The Fund remained nicely cash flow positive. We used this to dilute down some of the positions we had added in December and January.

 

We took advantage of a further rally in tech and most things Asian to sell the remainder of our Softbank position. The company continues to be a favoured name for us, but it is frequently in the headlines. We expect to have a better opportunity to add before the year is much older.

 

The Fund added new positions in US pharma company AbbVie and Colfax Corp, a diversified manufacturer. The former we bought in the secondary market – drugs sector debt has struggled to keep pace with the rally, expectation for further sector wide consolidation being rife. We believe AbbVie is unlikely to be involved and are being paid to be wrong! Colfax is a high yield market darling and a primary issue gave us a good level to establish a longer term position. Bonds closed the month around 3% higher than our purchase price – from here it should be more about coupon clipping than capital gain.

 

For government bonds we sold some of our strongly performing Australian bonds. They benefited from the China dispute and a soft domestic housing market. All that is fully in the price now. We retained a small amount – markets often overshoot and we’d like to benefit from that without taking too much risk. Story of the Fund really….

 

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 Strategic Bond Fund was launched in May 2018. As its track record is less than one year, regulatory restrictions prevent presentation of performance data in this review.


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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. 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.

Wednesday, March 6, 2019, 10:01 AM