Liontrust Strategic Bond Fund

Launch to 31 May 2018 review

The Liontrust Strategic Bond Fund was launched on 8 May 2018 and is now fully populated with investment ideas. The Fund is constructed as a portfolio of interacting risk positions with alpha anticipated to arise from sources in Rates, Allocation and Selection.

As this is the first month end for the Fund this report is longer than it will usually be; I therefore provide an abridged summary at the start. We welcome feedback on the written content as well as any of the positioning data and risk statistics provided. Once the Fund is 12 months old, and no longer subject to the MiFID II reporting restrictions, we will provide more detailed performance commentary and attribution data.

Summary

Rates

  • Underlying duration* 2.9 years, a beta of 0.6-0.7 against the market
  • Majority of duration in the US, half a year of this against a Canadian short
  • US 5year (short) / 30year (long) flattener instigated
  • Hedging euro investment grade credit duration contribution using OATs ((French government bonds))
  • Cross-market long Norway / short Germany at the 5 year maturity
  • Also long Australia versus the UK

Allocation

  • A little on the defensive side of neutral, Italian mini crisis created buying opportunities
  • 37% weighting to investment grade credit, of which 5% in floating rate notes
  • 22% exposure to banks and insurance, no AT1 (Additional Tier 1)
  • 24% high yield weighting

Selection

  • Companies’ bonds are often cheaper outside of their host currency
  • We like the commercial property landlords with low LTVs and good asset backing
  • High yield holdings are idiosyncratic in nature
  • Favoured names include Netflix, Drax and LKQ

Rates

The extreme overvaluation of high quality sovereign bond markets has abated somewhat over the last few quarters, a consequence of improving economic fundamentals and reduced monetary stimulus in the US. The model portfolio we were running ahead of the launch of the Fund was adding duration slowly by buying rates risk in the US as yields were rising there. Having started the year with an underlying duration* in our model of 2 years, we then increased this towards 3 years as valuations improved. Now that the Fund has been launched, we are invested with 2.9 years’ duration, remaining underweight interest rate risk on a longer term view but exhibiting some correlation to the generic bond market.

The majority of the Fund’s duration is in the US as the Federal Reserve is far further through the monetary tightening cycle than other central banks. It is highly unlikely that US base rates will peak significantly above 3% in this cycle. We view 3.50% on the US 10 year as a level where we would seriously consider removing the underweight interest rate risk stance that we have held since 2011. We have also long been advocates of US curve flattening and have instigated a short in 5 year Treasury futures versus a long position in 30 year Treasuries to capture this. 

Staying in North America the Fund is short Canada versus the US, with extreme valuations overlooking the natural long term convergence between economic activity levels of Canada and its larger neighbour. We are keen to open US breakeven positions and although 10 year breakevens approached our 200bps buy target during the Italian mini crisis, they did not quite reach our level. In the meantime we invested in the April 2019 TIPs (Treasury Inflation Protected Securities), which has a real yield of 60bps and is a good park of cash ahead of any extension into the 10 year.

In Europe we are short Germany versus a long position in Norway at the 5 year maturity. A recent legislative change in the Norges Bank’s inflation target has helped to create this valuation opportunity; whilst we do anticipate rate rises in Norway we believe these are further out and slower than the market currently anticipates.  We have hedged out the duration contribution arising from investment grade credit in euros by selling OAT futures. The Fund was a whole year short France versus Germany during the month but we halved this when the spread rose through 40bps during the market turmoil. Finally, the Fund is short duration in the UK with an offsetting long position in the Australian government bond market.

* The headline duration of the Liontrust Strategic Bond Fund is approximately 1 year longer than the measure that we refer to as the underlying duration. The difference between the two is that the latter 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. A line-by-line adjustment is available for anybody interested.

Allocation

In the last few months a little more value has returned to pockets of the credit markets. The Fund has a 37% weighting to investment grade credit, of which 5% is in floating rate notes. The yields on floating rate notes are benefitting from both the US interest rate cycle and the current dislocation in US LIBOR; capital upside is limited but we believe these represent a reasonable real store of value. The US credit market is a little cheaper than Europe in spread terms but there is not a massive amount to choose between them. 

The high yield weighting in the Fund is 24%; we have been happy to buy spread duration in higher quality high yield as we can and do easily control the overall interest rate risk within the Fund. There are no CCC-rated bonds in the Fund as the risk/reward equation is not presently favourable for them, and rarely is. 

The majority of the credit purchases were undertaken toward the end of May as the market turmoil surrounding the Italian political situation led to credit spreads widening; this gave us the opportunity to source some cheap corporate bonds for the Fund. Within credit the sum of the banks and insurance sector weightings is 22%, with 5% of this in senior debt and the rest split equally between lower tier 2 and tier 1. Should CDS indices rally from here we would look to extract some of the financials’ beta by buying protection on the iTraxx Subfin index, thereby prioritising the stockpicking alpha within the bonds over the associated beta. For the avoidance of doubt the Fund currently holds no AT1 (Additional Tier 1) securities nor Italian financials.

Selection

One of the advantages of launching a fund is that there are no stale holdings. Not only have we been seeking to identify the credits that offer the best current risk/return, we also believe we are able to target the most attractive bonds issued. One theme within the Fund is that we have numerous positions where the issuer’s bonds are cheaper outside of their home market currency. For example the Fund owns Telecom Italia (purchased after the spread widening), SES and Barclays in US dollars, Iqvia and Wells Fargo in euros and EDF and Welltower in sterling.

One part of the credit market that offers relatively generous spreads at the moment is the property sector. This is despite the fact that there is asset backing and normally decent covenant protections (based on maximum loan-to-value ratios). Holdings include Aroundtown, a German commercial landlord; this is an improving credit story where the Fund owns a combination of the hybrid bonds as well as senior debt.  Other examples include Vonovia (formerly known as Annington), Grainger, FDR and Welltower.

The high yield holdings are idiosyncratic in nature, the one discernible theme being those companies benefitting from technological disruption. Favoured holdings include Netflix, where we are fans of the content it is producing and the competitive advantage this gives the company.  Drax is an improving credit story as it converts old coal fired plants to renewable wooden pellets and its US dollar bonds offering good value. Companies supplying the auto industry can be good investments if they have sufficient scale; one such example is an auto parts supplier/distributor LKQ which has a huge network in the US and is making acquisitions to create a similar model across Europe.

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 issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Investment in the Strategic Bond Fund 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 Fund may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.

Disclaimer

This content 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. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. 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 5, 2018, 9:26 AM