Phil Milburn

How much duration?

Phil Milburn

The Liontrust GF Strategic Bond Fund is a total return fixed income portfolio. We view “total return” to mean that the fund will always be correlated to bond markets, as opposed to absolute return funds, which are meant to have a market neutral approach. 

Put simply, if investors have chosen to invest in a fixed income fund, we aim to deliver bond-like risks and returns.

Clearly, we will flex the asset allocation and duration of the Fund through the cycle as well as adding alpha to supplement returns. For each of the macro fund shape factors, we will have a portfolio beta of between 0 and two times the market weight. In this brief article, I will expand upon the Fund’s duration range of 0 to nine years.

The duration range of 0 to nine years takes the historic market duration of 4.5 years and allows us to have 0 to two times this exposure. For historic context, in the 15 years that David Roberts and I have been running this kind of strategy, we have had portfolios positioned with as low as one year’s duration when valuations became absurd and as high as eight years during the time of the financial crisis.

The concept of reducing the Fund’s correlation to them when rates markets are expensive has received no pushback in client meetings. We have received some questions, however, about why we chose 4.5 years as the market neutral duration. 

There are three reasons for choosing 4.5 years as the neutral duration point. First, this used to be the approximate realised average of the more than 600 global bond funds that invest flexibly and are available for sale in Europe.

Second, 4.5 years also used to be the duration embedded within the Bloomberg Barclays Global Aggregate Index. This Index has seen a huge increase in duration over the last 10 years due to the changing mix effect as it has grown from $28trn to $51trn in value and the convexity impact as yields fall (lower yields lengthen the duration). 

As can be seen from the green line in the chart below, the Bloomberg Barclays Global Aggregate Index used to have a headline duration of around five years. Included in its constituents were many mortgage bonds that frequently repaid earlier than their legal maturities, dragging the underlying index duration closer to 4.5 years.

An uglier index over time

Phil Milburn: How much duration - An uglier index over time

Source: Barclays, Bloomberg, Liontrust to end March 2018

The Index has lengthened in duration at exactly the wrong time for investors – as yields have fallen. As previously mentioned, this is both a mathematical effect and a changing mix effect. We are firm believers in managing through the cycle and completely index agnostic.

Thus, the final reason we have kept our mid-point duration range at 4.5 years is we have chosen to limit the absolute duration risk within the Fund. We view the increase in the Index duration to over seven years as a cyclical effect caused by monetary policy, the classic case of financial repression. If we were to blindly follow this, we would have increased Fund risk at exactly the wrong time. 

We continue to actively manage duration risk within a 0 to nine years’ range. We will not extend this range to adapt to a distorted market phenomenon as we care about our clients’ total returns and risk through the cycle and therefore we will not chase the most expensive risks in the market.

As yields rise, we will increase duration, but for now we remain underweight duration with a beta of about 0.6-0.7 times the much longer term average of 4.5 years, and significantly less than the current cyclical index high.

Key Risks & Disclaimer

Please remember that past performance is not a guide to future performance and the value of an investment and any 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.

This blog 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.

Thursday, May 3, 2018, 2:34 PM