Liontrust GF Absolute Return Bond Fund

Q3 2019 review

The Liontrust GF Absolute Return Bond Fund (C5 share class) returned 0.2%* in sterling terms in Q3 2019 versus the IA Targeted Absolute Return sector average of 0.6%. The primary US dollar share class (B5) returned 0.6%.

The quieter summer months merely served to exacerbate the feeling of déjà vu for the financial markets. News flow oscillated between negative developments on trade wars and manufacturing data, followed by the positives of reassuring language from central bankers and benign service sector conditions. 

The European Central Bank cut rates by 10 basis points to -0.50% and proposed infinite quantitative easing. However it does seem to finally have reached the understanding that the marginal effectiveness of monetary policy has decreased and fiscal spending would be a better economic stimulant. The Federal Reserve undertook two 25 basis point rate cuts during the quarter, framing these as “insurance cuts” against the current economic malaise. Previous instances of insurance cuts were in the 1990s when rates were cut by a cumulative 75 basis points each time; it is therefore no surprise that the markets currently anticipate a further rate cut at the Federal reserve’s October meeting.

One important market development during August was the inversion of the 2s10s US yield curve, i.e. 10 year US Treasuries temporarily yielded less than the shorter tenor 2 year ones.  This is frequently seen as a signal of an impending recession within the next six to 18 months. In this case we don’t believe the yield curve is telling us anything we don’t already know. There has been a huge slowdown in industrial production driven by the protectionist actions of politicians. So far there has been only limited contagion to services and consumer sentiment; employment remains resilient, albeit growing at a slower pace, and central banks are reacting to the threat of cross sector contamination ahead of it actually occurring. The rate cuts in the US, coupled with anticipation of further easing, has served to steepen the curve again with 2s10s finishing the quarter in positive territory by about 10 basis points.

With multi-century record lows in yields we are running the Fund defensively, with duration near the bottom of its 0-3 year range at 0.5 years. Our priority is to protect against a reversal in the extreme valuations of government debt and supplement the returns with ongoing alpha generation.

Carry Component

This component was the biggest generator of returns over the quarter. Nearly every bond made a small positive contribution with no standout performers in either direction.  As mentioned in previous reports we have been hedging out the duration contribution of the carry component’s credit in Europe. This had an opportunity cost over the quarter but is prudent given the overvaluation of the underlying government bond markets.

The weighting in US dollar floating rate notes was maintained at just above a third of the total assets. With US Treasury yields significantly below overnight rates one receives a far better yield on floating rate debt.  Obviously floating rate yields will come down as rate cuts happen, but we don’t believe that the US economy needs all the rate cuts the market is predicting. 

The carry component has great diversity across sectors and issuers, with a total of 114 bonds constituting the Fund’s carry at the end of the third quarter. This remains a good guide to the anticipated number of holdings for the foreseeable future; as the Fund grows we will top up existing positions; when bonds mature we will replace them accordingly.

 

Alpha Sources

(i) Rates

Rates alpha was on a balance a small negative for the quarter. The Fund has an inflation breakeven position via ownership of a Treasury Inflation Protected Security (TIPS) and selling the same duration contribution of Treasury futures against this. Inflation expectations reduced in the third quarter with breakevens therefore moving against us.

On the positive front the Fund made money out a France versus Germany box trade during the period.  The Fund was long the spread between 30 year French and German debt and short the corresponding 10 year spread; this was a liquid and very low risk way of generating alpha for the Fund.  The position was closed out having made a mid-single digit basis point profit.

(ii) Allocation

We continue to manage the Fund in its entirety and have been continuing the second quarter’s trend of risk reduction as valuations have become seemingly inexorably more expensive. Market oscillations have not created enough cross market dislocation for any allocation alpha trades recently. We would rather await better entry points than take unnecessary risks.

(iii) Selection

Just over 10 basis points additional performance was achieved, spread fairly evenly across each holding.  At the end of the quarter, selection represented 12% of the Fund’s assets, with only 1% of this being in high yield bonds.

 

Discrete 12 month performance to last month end*

 

Sep-19

Liontrust GF Absolute Return Bond C5 Acc GBP

1.7

IA Targeted Absolute Return

0.9

 

 

Discrete data is not available for five full 12 month periods due to the launch date of the portfolio.

 

Fund positioning data sources: UBS Delta, Liontrust.

*Source: Financial Express, as at 30.09.2019, total return (net of fees and interest reinvested).

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. 

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 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.

Thursday, October 10, 2019, 10:30 AM