Liontrust GF Absolute Return Bond Fund

Q3 2020 review

The Liontrust GF Absolute Return Bond Fund (C5 share class) returned 1.1%* in sterling terms in Q3 2020 and the IA Targeted Absolute Return, the Fund’s reference sector, returned 1.2%. The Fund’s primary US dollar share class (B5) returned 1.2%.

 

Bond markets returned to something like normal in the third quarter – well the QE, heavily manipulated market normality that has dominated most of the past decade. Continued central bank support for most asset classes allowed the Fund to make more sedate progress than during the roller coaster ride that was the first half of the year.

 

Volatility continued to drop. Although longer-dated bonds could fall dramatically in response to aggressive economic stimulus, the short dated nature of the Fund’s assets should protect from the worst of such moves.  This could offer us the opportunity to move back to more normal levels of market exposure; at the end of the third quarter, exposure to interest rate risk remained well below the fund’s average.

 

Market backdrop

Covid-19 continues to be the main driver of market sentiment. We discussed in the previous report our expectation that:

 

  1. Any recovery would not be V-shaped
  2. At a minimum, we did not expect growth to rebound fully until the end of 2021 at the earliest

These projections remain intact. Although global growth is set to be positive for the remainder of the year, some of the early Q3 momentum appears to have been lost. This is little surprise given the need to introduce mobility restrictions in Western Europe and, to a lesser extent, in the US and Asia. There are, of course, many reasons to be optimistic and certainly the worst case predictions of February and March – both the potential human and economic toll – thankfully have failed to fully materialise. Cold comfort for anyone directly affected.

 

Central banks have been reminding us almost daily that a second economic dip is an inevitability. In truth, the rhetoric has been aimed at politicians – at the time of writing it remains unclear if we will see a further stimulus package passed in the US prior to the November presidential election. The uncertainty created around this one single event weighed on risk markets for much of the quarter, although only started to grab headlines when even the mighty Nasdaq fell for a few days in late September.

 

We have been asked often whether a Trump or Biden victory would be beneficial for our strategy. In truth, it matters little. Our short-dated credit portfolio is unlikely to be impacted much either way and we have little in the way of longer-dated risk right now, preferring to wait and see which way markets move before committing. That is the benefit of a conservative return strategy – less need to guess which way the wind will blow.

 

Curve control – in practice, if not in theory

One big theme for many economic commentators has been the prospect of deeper forms of monetary policy. Some, notably the Modern Monetary Theorists, have insisted that yield curve control and negative rates are a must to support almost limitless degrees of government borrowing. With a little help from an ever-expanding central bank balance sheet.

 

Although the US has resolutely refrained from overtly following said policies, the impact on bond markets of crisis response has been clear. Short-dated bonds (where the assets of the fund are invested) have been remarkably stable since March. This reflects the extent to which market participants believe the Fed’s forward guidance – namely that rates are unlikely to rise prior to 2023. Naturally, this affords a high degree of protection to our short-dated bonds.


US 5-year treasury yield


At the same time, pro-inflation policies such as fiscal stimulus and the Fed moving to a “symmetrical inflation target” have had a detrimental impact on longer dated bonds.


US treasury yield spread


Indeed, the gap between 5 and 30-year US securities has recently widened to 12-month highs – reflecting a combination of market belief the Fed can deliver and fears that the price to pay for wave after wave of stimulus is higher rates and inflation in the longer term. The Fund is designed with limited scope to play in these more risky assets, a material difference from traditional investment grade or indeed strategic funds.

 

Carry Component

We split the Fund into the carry component and three alpha sources for clarity in reporting, but it is worth emphasising we manage the Fund’s positioning and risk in its entirety. As a reminder, the carry component invests in investment grade bonds with <5 years to maturity, this is exactly the type of bond the Fed’s SMCCF (Secondary Market Corporate Credit Facility) program is buying. 

 

The Fund continued to rotate out of floating rate notes (FRNs) within the carry component. As you may know, changes to legislation will see the phasing out of LIBOR (the bedrock for historic FRN valuations) in due course. It is a pleasant confluence of events that, just as the market is becoming in some ways less certain, so too is it less attractive from a total return perspective. We generally use FRNs to provide income at a time of rising interest rates – clearly rates are not going higher for some time. By the time they do, we would expect LIBOR successors to be embedded in the market.

 

Investment grade issuers normally take a break for summer. This year, there has been less of a lull and we continue to find nice, solid companies to invest in that are prepared to issue sub-5 year dated debt.

 

Alpha Sources:

 

Rates

There have been few changes to rates positions of late. Most of our core positions are adding gently to Fund performance – they aren’t particularly exciting, but that is kind of the point of the Fund!

 

We remain short 5-year German bonds as a hedge against duration in the carry portfolio and to offset market direction in our Swedish sovereign bonds. Those spreads have been very stable, which suits given we pick up some nice income from a calm market.

 

Through the period we added a little 7-year US Treasury exposure. Again, we hedged out the duration by selling 5-year US futures. Over the next two years, the bonds will roll shorter but the futures obviously remain static. We receive the princely sum of a 1% capital gain (or 20bp income) over the period. Dull, but as an example that’s close to the yield on 10-year UK bonds, 30-year French ones

 

Markets are very expensive of course. As we end the quarter, we have around 0.5 years duration at fund level. That’s against our maximum of 3 years and through-the-cycle average of 1.5years.

 

Allocation

During the second quarter, the Fund made money out of being long risk CDX IG, the US investment grade Credit Default Swap index, versus short risk the iTraxx Europe Credit Default Swap index (this index is often referred to as “Main”). Profits were taken, then the Fund entered back into the position when the differential between CDX IG and Main reached 10 basis points again.

 

Late in the period, credit volatility rose once again – led by equity softness. US investment grade indices were used as a hedging tool by the market. As a result, the spread between US and Euro credit widened. We decided to close the position at a small loss but inside our stop loss discipline. There is a danger in writing up our strategies: they either all appear as “winners” or straight forward to profit from. That’s not the case. It’s important to reflect on the benefit of stop loss and review disciplines – they are one of the major reasons the portfolio generally continues to deliver small, incremental returns.

 

Selection

The fund has benefited from a small selection of longer-dated corporate bonds. Our overall process (for all Liontrust GFI funds) generally follows “sustainable” themes. We do have specific ESG criteria of course, but here we mean: is a company operating in a sector which is generally favoured by societal trends and importantly, can that be sustained over the life of our investment so they pay us back!

 

At the end of the quarter, the Fund held two bonds with a maturity longer than 15 years – Eli Lilly and Danaher.

 

Eli Lilly has been much in the news of late. As one of the world’s leading pharmaceutical companies it has been part of the race to find treatments for Covid-19. In particular, it is concentrating on “old science”, developing antibody-based early stage treatments as opposed to a new style vaccine. This of course is only a fraction of its pipeline.

 

Danaher may be less well known. It is a US-listed conglomerate focusing on three areas: Life Sciences, Diagnostics and Environmental Solutions. Needless to say, such services are in high demand. Many people have noted the bifurcation in US equity markets – anything “big tech” has done well; everything else not so much. As a point of reference, by the end of September, Danaher’s equity had risen over 50% on a 12 month basis. Market cap was above US$100bn. We are not the only ones who like it.

 

Discrete 12 month performance to last month end**

 

 

Sep-20

Sep-19

Liontrust GF Absolute Return Bond C5 Acc GBP

3.0

1.7

IA Targeted Absolute Return

0.1

0.9

 

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

 

*Source: Financial Express, as at 30.09.20, total return (net of fees and interest reinvested), C5 class.

 

**Source Financial Express, as at 30.09.20, total return, C5 class. 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.

 

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.

Wednesday, October 14, 2020, 12:35 PM