Liontrust Strategic Bond Fund

July 2018 review

Global bond markets appeared to do little during the month of July. Index level returns were around zero. Yields on most sovereign bonds rose a little during the period. That apparent lack of volatility hid the fact that the market remained full of opportunities. Fortunately we were able to take advantage of many of those.

Recent months have been dominated by three drivers, each adding a bearish tilt to risk: Italian politics, Quantitative Easing (the ending thereof) and trade wars. June was a little bit of a risk-off month as investors focussed on the negatives of each of those drivers. Broadly, in late June/early July we positioned for a modest reversal of that negative sentiment which proved to be a correct strategy in July.

Macro data were simply too supportive and fears of a global trade war too over blown to justify the credit sell-off we saw in June. This view is supported by strong corporate earnings, never really a worry given over 6% nominal US growth in the second quarter. On a longer term basis the credit market is undoubtedly late cycle in nature; thus as the market moved back to better levels we started to reduce some of the credit risk in the Fund.

European politicians are now on holiday so the chat, coverage, and negativity characterising current political debate has to an extent been put on hold (at least in mainstream media). Brexit and Italian politics – for the first time in several months – are longer dominating the headlines.

Trade war rhetoric is being watered down. Issues still remain of course. NAFTA and China continue to be of concern for emerging market investors in particular. However, some signs of resolution between the US and Europe have been supportive for G7 credit (and equity) markets.

Nothing much has changed. The three biggest threats to markets still exist and are likely to return after the holiday season, albeit in possibly watered down format. For now, markets continue to provide opportunities without the need to take too much of a directional bet. Earnings may continue to provide a positive focus and aggregate macro data remains sound. Prices though have rebounded, so it still seems sensible to look for idiosyncratic, mispriced macro and micro opportunities.

Rates

The Fund continues to run with a low beta duration stance; when the rates markets cheapen we add some marginal risk to the portfolio. We took advantage of volatility in July to generate a little alpha and net added to duration, finishing the month with a factor-adjusted duration of 2.8 years* (3.8 years unadjusted). The short Canadian 10 year futures relative to the US has started to move in our favour and was one of the stronger aids to performance over the month.

We reduced the size of the yield curve flattener in the US (short 5 year bonds, long 30 year bonds) but will increase the position again should we witness any steepening retracement. The US dollar remains our favoured rates market and we fastidiously keep the exposure to eurozone and UK duration low.

Allocation

There was not a massive change in the physical allocation of assets in the Fund during July. The combination of conventional investment grade bonds (33%) and floating rate notes (6%) summing to 40%, and high yield bonds representing 24% of assets. However, we were active in using derivative overlays to adjust the credit risk profile of the Fund. At the very end of July, the Fund bought just over 5% protection (established a short risk position) in the US CDX High Yield index. Thus, the net weighting in the Fund to high yield is 24% physical bonds minus the just over 5% derivative overlay which nets to a little under 20%; furthermore the holdings within this are higher up the credit ratings spectrum.

Selection

Technical drivers also can and do impact individual corporate debt. A name we have long liked is Softbank, best thought of as a technology and telecom investment vehicle. The company debt was reclassified to the “financial” sector during the month. The reclassification resulted in several forced sellers (many funds are restricted in sector weightings) and bonds fell several per cent. Nothing fundamentally had changed, we liked the business profile and bought bonds. Unsurprisingly they subsequently recovered and as the month drew to a close had returned to “fair value,” we therefore banked the profits on the additional purchase.

When times are tricky it can be difficult for companies to raise new debt. Goldman Sachs has had a few blow-out quarters of earnings recently. However, even against their strong backdrop, Goldman had to offer investors a significant concession to raise debt during the month. We bought the new issue for the Fund; by month-end half of the 30bps spread value gap had been realised – we continue to hold out for a little more.

*source: 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. 


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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, August 8, 2018, 11:46 AM