Liontrust European Enhanced Income Fund

August 2019 review

The Liontrust European Enhanced Income Fund returned -0.8%* in sterling terms in August. For comparison the MSCI Europe ex-UK Index returned -1.2% in sterling terms return and -0.8% in local currency terms.

 

The Fund’s most recent income distribution was announced on 31 August 2019, taking the Fund’s 12 month income yield to 4.7%. The Fund targets an income level of 1.25x the yield on the MSCI Europe ex-UK Index. The index yielded 3.5% over the same period.

 

Donald Trump launched another Trade Wars offensive in August with the announcement of a 10% tariff on US$300bn of Chinese imports, effectively covering all remaining imports from China not already levied. Later in the month he raised the threatened tariff level to 15%, to be implemented from 1 September, but carved out a sub-list of goods which would benefit from a tariff delay in order to support US consumption ahead of Christmas.

 

Investors reacted in classic risk averse fashion, selling equities and moving into bonds. This trade was hastened by the knowledge that the US Federal Reserve explicitly considers global trade frictions to be among the economic risks it needs to react to. When announcing its recent rate cut, the central bank cited “the implication of global development for the economic outlook” as part of its rationale. Long-dated US government bonds pushed down to record low yields, and the US yield curve inverted – a much discussed phenomenon due to its potential as a leading indicator of economic recession.

 

Aside from pushing them into negative territory, the impact on equity markets included a strong preference for defensive sectors over cyclicals and the marked underperformance of those with ‘value’ hallmarks. As we have discussed in previous reports, the Fund has a long-standing bias to value stocks as we believe global interest rates and bond yields are unsustainably low.

 

Indeed, in the recent stampede into bonds, the entire German yield curve was pushed into negative yielding territory, part of over $15 trillion of government debt worldwide currently negative yielding. As and when rates normalise, value stocks should benefit from a long-overdue reversion to more typical share valuations, and indeed there are indications that August could have represented a blow-off low for bond yields. After all, a return of minus 0.7% on German ten year bunds does seem rather uncompelling, given the opportunities for yield in equities.

 

In August however, our value exposure presented a strong headwind. This was most evident through the Fund’s large allocation to financials, which is perhaps the most obvious ‘loser’ from lower interest rates. The c.25% of the Fund invested in the sector contributed around half of this month’s underperformance of the MSCI Europe ex-UK index. An outlook statement contained within Dutch banking group ING’s (-12.1%) Q2 results neatly encapsulated the challenge for the sector: although ING achieved loan growth and stable margins, the bank warned that the ongoing low interest rate environment is expected to put pressure on net interest income in future periods. 

 

Revenue and earnings progression at French insurer AXA (-9.7%) looked solid in adjusted terms, up 8% and 10% respectively, but reported net income was hit by exceptional charges which included a write down on the value of its holding of AXA Equitable Holding following its deconsolidation. AXA Equitable Holding – the company’s US subsidiary – completed an initial public offering on the New York Stock Exchange in 2018, and AXA has since reduced its holding to below 40%.

 

If the UK has political difficulties at the moment, spare a thought for the Italian public, who have enjoyed 61 different governments in the last 74 years. The uniquely unstable coalition of radical anarchists the 5-Star Movement and the right-wing populist [formerly Northern] League unsurprisingly collapsed when the League finally withdrew its support. Markets feared potential new elections in Italy, but 5-Star found the prospect of losing office less appealing than working with their old enemies, the centre-left PD party. Hence academic Giuseppe Conte remains as PM, providing some continuity of government at least.

 

In the short term, this is positive for Italian assets, and indeed so far this year Italy is the best-performing major European market. The immediate consequence is that a collision course with the EU over budgetary rules has most likely been averted, removing the threat to the Italian bond market from a damaging confrontation with Brussels. How stable the new coalition proves to be is yet to be seen, but it could hardly be as fractious as its Salvini dominated predecessor.

 

Terna (+2.8%) – one of the Fund’s Italian holdings– made a solid gain on the month, although admittedly this is likely to be more a function of the electricity grid’s status as a low-risk defensive utility in a month when dull earnings predictability came into vogue. Shares in Endesa (+3.7%) also moved higher as part of the same trend.

 

French construction and infrastructure concessions group Vinci (+5.8%) reported 10% revenue growth in the first half of 2019, with operating profit rising 9.1% to €2.1bn. Top-line growth was boosted by acquisitions to the tune of 3.7%, following the 2018 purchases of AWW airports and Belgrade airport and the May 2019 acquisition of London Gatwick. These deals boosted its Airports division’s revenue by 44%. Group order intake was also solid, pushing the order book up by 11% year-on-year to 36.2bn. The business comprises a mix of cyclical (construction) and defensive (returns from owning and operating toll roads are fairly bond or utility-like). This could have left it straddling August’s sector delineation, but the strength of results was enough to push it into positive territory.

 

Having lost ground in July on slowing sales growth, shares in Thule Group (-9.8%) again struggled after its CFO of eight years left to take up a CEO position elsewhere, although the well-respected Thule CEO Magnus Welander remains in place. In late July Amadeus FiRe (-14.5%) had reported on a 13% gross profit increase in the first half of 2019 and raised its guidance for full year earnings growth from 5% to 10%. The shares become an easy target in August’s risk-off atmosphere, with the perception of recruitment being about as cyclical as it gets.

 

Positive contributors included:

Orkla (+7.1%), Vinci (+5.8%) and Endesa (+3.7%).

 

Negative contributors included:

Amadeus FiRe (-14.5%), ING (-12.1%) and Thule Group (-9.8%).



We continued to refrain from writing covered call options in August. However, volatility on the European equity market did pick up during the month, which may lead to more attractive premiums.

 

The Fund’s primary share class is currency-hedged in order to provide insulation from movements in the value of the euro and other European currencies. The euro depreciated by 0.6% against sterling in August.


 

Discrete years' performance** (%), to previous quarter-end:

 

 

Jun-19

Jun-18

Jun-17

Jun-16

Jun-15

Liontrust European Enhanced
Income I Hedged Acc

2.1

0.7

17.7

-10.4

18.7

IA Europe Excluding UK

3.3

3.1

29.2

4.5

4.1

Quartile

3

4

4

4

1

 

*Source: Financial Express, as at 31.08.2019, total return (net of fees and income reinvested), bid-to-bid, institutional class. Non fund-related return data sourced from Bloomberg.

 

**Source: Financial Express, as at 30.06.2019, total return (net of fees and income reinvested), bid-to-bid, primary 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. Investment in Funds managed by the European Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. Investment in the Liontrust European Enhanced Income Fund writes out of the money call options to generate additional income. These call options will be “covered”. Unitholders should note that potential capital growth of the Fund would be capped if these call options are exercised against the Fund and the Fund’s capital returns could therefore be lower than the market in periods of rapidly rising share prices.

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, September 17, 2019, 2:31 PM