Liontrust Strategic Bond Fund

May 2019 review

The Liontrust Strategic Bond Fund returned -0.1%* in sterling terms in May, compared with the 0.3% average return from the IA Sterling Strategic Bond sector.

 

The Liontrust Strategic Bond Fund is now over one year old which means that we are able to comment on performance. Though the Fund edged lower during May, performance since inception has been solid. It has returned 4.1% compared to 3.2% average return made by the sector.

 

In May financial markets suffered from a tariff tantrum. The month started briskly with President Trump issuing a tariff ultimatum to China and eventually raising tariffs from 10% to 25% on US$200bn of imported goods, to join US$50bn worth of goods already at that level. He additionally threatened raising duties on a further US$325bn. I should note that this adds up to more than the US$539bn of Chinese goods imported into the US in 2018, but facts are so passé. Beijing retaliated with hikes on US$60bn of US goods.

 

The threat to economic growth that the trade wars create cast a long shadow over markets in May. Even as it looked like trade talks between China and the US might have been making progress, Trump turned his attention to Mexico and used Executive Privilege to unilaterally impose tariffs there. The rationale for Mexican import tariffs is based on forcing Mexico to limit illegal immigration into the US as opposed to being grounded in economics. It is not new news that the current “leader of the free world” uses playground bully tactics; however, the speed with which he has reneged on the spirit of previous agreements does call into question the value of negotiations for other countries. Specifically here the USMCA (US Mexico Canada Agreement), which is the successor to NAFTA, is not yet fully passed into law yet is already being superseded. Inevitably, markets that were already in a jittery mood took fright at the heightened uncertainty.

 

US 10 year yields rallied from 2.5% to 2.1%, the market is now pricing in four US rate cuts in the next 12 months with a 95% probability of the first one being in September. The vast majority of sell side forecasters of interest rates have now changed to expecting 50-75bps of cuts over the next year. Federal Reserve Chairman Powell has stoked the monetary policy euphoria, recently stating “…we are closely monitoring the implications of these [trade war] developments for the US economic outlook and, as always, we will act as appropriate to sustain the expansion.” I would strongly highlight the caveat that if the US and China can come to an agreement, then a major economic hurdle is removed. Furthermore, the Mexican tariffs are viewed by Congress as deeply damaging and do not have Republican Party support.

 

The Federal Reserve here is playing with fire: with wage inflation already on an upward trajectory the US economy does not need more stimulus. The direct effect of tariffs could now be approximately 0.5% off global growth; the World Bank has downgraded its 2019 forecast to 2.6% from 2.9%, slightly below trend but not a disaster. The indirect effects on business confidence and financial markets has caught the Federal Reserve’s attention more, we continue to believe they put too much of a weighting in their decision making on asset prices.

 

Irrationality is not the sole preserve of the White House and has permeated through the financial markets. We now have the lowest 10 year Bund yields ever at -0.2%, yet German headline inflation is at 1.4% and core inflation even higher at 2.0%. The European elections did not point toward any upcoming stress on the eurozone members, with populist parties gaining far less ground than initially feared. Here in the UK there was something for everyone with the Brexit Party (effectively the UKIP reincarnation) garnering the most seats and the Remain-supporting parties taking significant share from Labour and the Tories. On the subject of the latter, the UK shall receive a new Prime Minister in the next month or two who will try to find a different way to solve the great Brexit paradox – anything that voters would approve of is not deliverable and anything deliverable would not get voted for.

 

Worried that the UK politics was getting too much attention, Italy has shouted “hold my beer” as Salvini takes advantage of Lega’s good polling results to consolidate power in the ruling coalition. While a lot of it is posturing, the weaker Italian economic growth has a direct feed through to a worsening fiscal position. This, in turn, has led to Italy being subject to the EU’s excessive deficit procedure. There is a grey area here between fiscal prudence and promoting pro cyclical austerity, but one thing that is without doubt in our minds is that Germany is running with an excessive fiscal surplus. Amusingly, 5 year Italian government debt now yields more than that of Greece.

 

Rates

Fund duration is currently in the 2.5 years ballpark having been a smidgeon higher at month end. Developed market government bonds are priced at ludicrous levels but investor positioning has not been fully cleaned out and so we retained a low duration but not no duration. To reiterate, our longstanding preference for US duration over that of the eurozone remains based on having a positive real yield and being further through the monetary cycle. Within the US, we took profits on the 10 year against 30 year curve steepener, the Fund now has very little 30 year exposure but is no longer negative. We prefer to spend the risk budget on a similar theme of a far too dovish Federal Reserve by adding to the inflation protection in the Fund; the weighting to TIPS (Treasury Inflation Protected Securities) has been increased and represents about half of the duration of the Fund. We took some profits on our short Canada versus the US dollar position during May and would look to re-enter this on any retracement in the spread.

 

Kiwi government debt had been a relative laggard compared to other high quality sovereign debt, half a year’s exposure was added there with some of the risk mitigated by using futures to short the overbought Australian government bond market against it.

 

Allocation

Risk assets obviously reacted to the trade wars with most major equity indices down over 5% in May (the FTSE 100 was down less due to weak sterling). Corporate bonds didn’t do too badly, there was some concertina effect with higher beta areas such as subordinated financials coming under pressure. As a reminder we have been de-risking the composition of the Fund’s investment grade holdings over the last few months and would welcome a period of spread widening to create opportunities. Credit Default Swap (CDS) indices saw more of a shakeout and we have started to add to the Fund’s high yield exposure using the CDX HY index (a US high yield CDS index).

 

Selection

May was more about the macro than the micro, but selected stock level activity still added value to the Fund. We sold the Fund’s only remaining banking sector perpetual debt, a Bank of America Merrill Lynch US Dollar bond, at the highest cash price it has reached. Furthermore, one of the higher risk investment grade names the Fund was exposed to in euros, Covivio, was sold at the tightest spread it has been at since the Fund was launched. The primary markets continued the theme of the last couple of months by squeezing all of the relative value out of the majority of new deals. We did manage to pick up a couple of bargains; some longer dated US Dollar Bristol-Myers Squibb bonds, which were issued as part of the jumbo acquisition financing of Celgene, as well as some decent value Barclays senior debt in sterling.

 

Discrete 12 month performance to last month end*

 

 

May-19

Liontrust GF Strategic Bond Fund B5 Acc USD

5.70%

EAA Fund Global Flexible Bond – USD Hedged

4.20%

 

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. 

 

*Source: Financial Express, as at 31.05.2019, total return (net of fees and income reinvested), bid-to-bid, institutional class.

 

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. 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.
Tuesday, June 11, 2019, 2:49 PM