Liontrust GF High Yield Bond Fund

Q3 2019 review

The Fund (C5 accumulation class) returned 2.0%* in sterling terms in Q3 2019 versus 0.8% from the ICE Bank of America Merrill Lynch Global High Yield Index (GBP hedged) and a 0.7% average from the IA Sterling High Yield sector. The primary B5 US dollar share class returned 1.3% versus 1.2% from the ICE Bank of America Merrill Lynch Global High Yield Index (USD hedged).

 

Having seen strong returns in the first half of 2019, the global high yield market plateaued somewhat in the typically slower summer months of Q3, with income driving US dollar returns of 1.3% (0.8% in sterling terms and 0.5% in euros).

 

European high yield again had a stronger quarter than its US counterpart, generating a return in US dollars of 2.0% versus 1.2%. However, the more important story is the persistent outperformance of higher quality bonds as, for example, both US dollar and euro BBs outperformed the market, carrying on the trend we discussed in the last quarter. As a reminder, BBs are the most sensitive part of the market to government bond yields, and with ten year government bond yields falling c.30bps in the quarter, BBs benefitted.

 

With central banks crushing yields it has pushed some investors in to riskier areas. However, it seems high yield investors are not keen at this stage in the cycle to reach very far down the credit spectrum. As a result, we are seeing a growing gap between the yields offered by high quality and lower quality high yield bonds. It is perhaps akin to a high yield market version of the growth/value disparity we’ve seen in the equity market. With a greater proportion of the market made up of lower quality bond issuers, this is why we see US high yield underperform Europe at the headline level. However, as ever, there’s a lot more going on in high yield than headlines suggest, which is why it is a great market for stock-picking funds!

 

The Fund

Our stock picking within single B credit, which as previously noted has generally lagged higher rated BBs, was a major driver of the Fund’s performance in the period. For example, US dollar denominated single B rated bonds held in the Fund like aerospace parts and service company, Transdigm (in fact a low single B credit) and US telecom CenturyLink were large positive contributors. We estimate that around two thirds of the Fund’s outperformance in the period came from single B rated holdings, which is significantly punching above their weight in the Fund.

 

We have been dipping our toes in lower-rated high yield credit, with the growing gap in the yield differential between higher quality and perceived low quality creating some opportunities for stock-picking. It is often the case that good quality business over-stretch in terms of their borrowing, perhaps for an acquisition or to distribute capital to owners/shareholders. We tend to like these businesses so long as we see a good balance of interest between the owners, managers and creditors of the company.

 

These are the characteristics we see in French equipment leasing company Loxam (which recently acquired a Northern European peer), investment holding company Softbank and industrial air and gas handling company Howden. The latter is actually a rare foray (we tend to prefer listed businesses) in a private equity leveraged buy-out (LBO), where the new owners have bought this business from one of our existing holdings, industrial company Colfax. Howden is a cyclical business with a heavily indebted balance sheet, however it is cash generative and the new owners have paid for a decent amount of the consideration with their own funds rather than borrowed money. We felt the yield of 11.5%, issued in a week when market sentiment was a little wobbly, was a compelling opportunity for what is undeniably a risky holding. Incidentally, we were told that we were the only investor in Europe looking at the Howden new issue.

 

Each of these new riskier holdings are around 0.75% of the Fund. We have reduced other riskier holdings, such as oil exploration and production company Enquest at high prices for the year in order to control overall portfolio risk.

 

The Fund’s holding in petrol station retailer EG Group was short-lived. Soon after the new issue, the company announced yet another large acquisition, with arguably aggressive assumptions behind how much value they can extract from the merger. Our conviction in management weakened and we sold the bonds only marginally lower than where we purchased them in Q2.

 

We try to avoid accumulations of thematic risk in the Fund. Our one exposure to the US energy market, Antero Resources, a 0.75% holding in the Fund, was the worst performing individual stock in the portfolio during Q3, costing the Fund an undramatic 7bps in total return. We like Antero because of its hedge position and decent quality assets in the Appalachian region. However with US domestic gas prices weak, the sector in general is performing very poorly. Unsurprisingly, as a large component of high yield indices, US energy bonds are causing a drag on the returns of index or quasi index funds. Happily our other two energy holdings, which are both North Sea exposed and traded out of London, away from the negative sentiment associated with domestic US energy producers, contributed positively to Fund returns in Q3.

 

Outlook

In the first few days of October we have seen some weakness in high yield bonds and risk assets in general. Our favoured measure of general market value, the ‘spread’ on bonds excluding CCCs and bonds issued by energy companies, has increased by close to 0.6% and is approaching 3.5%. We believe a 4% spread on this sub-index represents good value for long-term investors and we are keeping a close eye in order to increase risk in the Fund. We will be comfortable doing this as, although we recognise economic data points to be slowing, we believe companies are generally in good shape and a slowdown will represent an earnings squeeze rather than a material increase in default risk for most companies.

 

As mentioned, we have added a little stock-specific, riskier credit, but at the portfolio level we would still describe our positioning as reasonably defensive. We continue to favour US dollar-denominated bonds. Fixed income in general remains very expensive and we retain our short bias towards duration, or interest rate sensitivity.

 

Discrete 12 month performance to last quarter end (%)*:

 

Sep-19

Liontrust GF High Yield Bond C5 Acc

6.6

ICE BofAML Global High Yield Hedge GBP

5.4

IA Sterling High Yield

4.7

 

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, C5 share class, total return, net of fees and interest reinvested. As at 30.09.19. The primary share class for this Fund is in US dollars (B5) but we are showing the C5 sterling-hedged class to compare against the IA Sterling High Yield sector.

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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, 10:39 AM