Liontrust GF SF European Corporate Bond Fund

Q2 2020 review

The Fund returned 6.0% in euro terms over the quarter, outperforming the iBoxx Euro Corporate All Maturities Index’s 5.3%*.

 

This return was driven by the overweight credit position as corporate bonds rebounded strongly over the period, outperforming government bonds and benefitting from stronger risk appetite and favourable technical support. High yield performed particularly well, while investment grade was not far behind.

Stock selection was the primary factor, particularly within our favoured bank, insurance and telecommunication sectors, which recovered strongly from a tumultuous first quarter. Financials rallied as fears of a repeat of the financial crisis were dispelled, with our higher beta subordinated holdings delivering a strong contribution, and our longer spread duration holdings within telecommunications also performed well. This far outweighed the drag from more defensive positions, such as our Bund allocation and short to high yield, as well as the negative contribution from being underweight the autos sector, which also recovered well.

Overall, the recovery in corporate bonds counterbalanced the sector’s underperformance from Q1, with credit positioning now broadly flat, costing the fund just 1 basis point relative to the index over the first half of 2020, despite European spreads remaining wider over the period. This reinforces our conviction in our high-quality portfolio, which we believe continues to be well positioned to withstand the significant impacts arising from the Covid-19 pandemic.

Despite the general risk-on tone in markets, government bonds held up remarkably well over Q2, demonstrating continued correlation with risk assets, and, as a result, we saw a negative contribution from the fund’s short duration position. While German 10-year Bund and US 10-year Treasury yields were broadly unchanged over the quarter, this belies the underlying volatility, trading in respective ranges of 31bps and 43bps during the period.

We saw a huge contrast in Q2 compared with the first three months of the year, as central banks and governments responded swiftly and in coordinated fashion to the threat posed by Coronavirus. They provided enormous stimulus to support economies both domestic and global and the combination of slowing infection rates, easing lockdown measures and early signs of a rebound in data contributed to positive returns from financial markets.

That said, the impact of Covid-19 on economic activity has been significant, with the European Commission projecting a 7.4% decline in the bloc’s GDP over 2020. As stated, central banks have been quick to respond to prevent the economic situation evolving into a financial crisis, ensuring borrowing costs are kept low and liquidity is available across the board.

The European Central Bank (ECB) continued quantitative easing (QE) and eased collateral requirements to help support small and medium-sized enterprises. European Commission president Ursula von der Leyen called for the power to borrow €750 billion for a recovery fund to support the worst-affected EU regions. This would be in addition to a €540 billion rescue package agreed in April. The ECB also offered support, expanding its Pandemic Emergency Purchase Programme (PEPP) to €1.35 trillion.

In the US, the Federal Reserve response has been significant in both size and speed, committing to unlimited government bond purchases and increasing the size of its quantitative easing (QE) programme. This has been targeted at investment grade companies but, importantly, was expanded to include corporate debt rated investment grade prior to 23 March, helping alleviate fears over access to liquidity for companies downgraded to high yield. The Fed has committed to keeping rates low until it is confident economic activity is back on track towards full employment and inflation at the 2% target level. As for the UK, the Bank of England increased the size of its QE programme, keeping borrowing costs low, and liquidity has come via the Covid Corporate Funding Facility (CCFF). The furlough scheme is estimated to be supporting 7.5m people, helping to reduce the impact of the lockdown on the workforce.

In terms of corporate behaviour, companies have looked to ensure they have adequate liquidity to manage their way through this downturn. Access to recovery funding, use of fiscal support programmes, equity raises and dividend cuts have all been regular features as companies focused on balance sheet strengthening. This resulted in record levels of new corporate bond issuance, but the combination of strong technical support and renewed investor sentiment has meant this supply has been well received by the market.

As expected, the impact of lockdown strategies and uncertain economic outlook has had a negative impact in terms of credit downgrades. Our portfolio has not been immune, but we have not any seen downgrades to sub-investment grade, reflecting the quality of the issuers held. While credit metrics across investment grade have been largely able to weather the storm due to strong pre-Covid starting points, earnings pressure has weighed heavily on already-weak metrics in the high yield space, leading to an acceleration in defaults. These have been predominantly US led, with the retail and energy sectors suffering the most.

With high yield more exposed to impacts of the pandemic, we took out a -5% short position to the European market in April. In addition to anticipating a rise in defaults, we felt this also provided additional downside protection in the event of further market weakness. Following the end of the quarter, we elected to close the short as we see European high yield as less exposed to defaults than the US, while the asset class will also indirectly benefit from the EU recovery fund. Unlike in the US, the European HY CDS index is still yet to suffer a default.


Overall, the second quarter was dominated by positive sentiment as reductions in the infection rate allowed economies to restart and there were signs of promise in the early stages of vaccine development. This resulted in initial data releases suggesting the recovery may turn out to be sharper than widely believed, further boosting sentiment. However, the latter stages of the quarter saw renewed fears over a second wave, with new infections rising in the US and several emerging markets struggling to contain the virus. This serves as an important reminder that easing of lockdown measures must be carefully managed.

We continue to maintain high conviction in our existing holdings, as we have done throughout the crisis, and portfolio activity was fairly muted over the second quarter. As previously mentioned, new issuance was a feature of Q2 as corporates sought to bolster near-term liquidity concerns, with the return of investor risk appetite alongside central bank purchasing programs seeing this issuance well absorbed by the market.

We added to our existing position in Nationwide Building Society, which we believe was oversold during the early stages of the outbreak when the market mistakenly believed this was another financial crisis. The depressed valuations offered an attractive level to top up our position and the company has subsequently rebounded strongly. Against this, we reduced our allocation to Bunds, as we looked to incrementally add risk to take advantage of the market sell-off. In the latter stages of the quarter, we also reduced our holdings in BNP Paribas and Societe General bonds on valuation grounds following strong performance through the rally.

In line with our previous guidance, we increased the longstanding short duration position back to two years relative to the index, after 10-year Bund yields fell to near all-time lows, reaching as low as -0.59% before ending the period at -0.46%. The short position is currently expressed solely through the German market, after we rotated from the US market back into Europe on relative value grounds. 

Looking to the rest of the year and beyond, a near-term deterioration in credit fundamentals is inevitable given the significant disruption to corporate earnings but we remain positive on investment grade credit: it offers a rare source of yield and strong fundamentals give enough headroom to withstand much of the negative impact. As detailed earlier, this is combined with a high level of technical support fuelled by central bank purchasing, alongside an expected reduction in new issuance following elevated levels in H1. Companies have ensured they had funding in place but their focus is now turning to balance sheet repair. With credit spreads above long- term average levels, there is scope for a gradual grinding tighter in spreads.

As stated, we remain committed to existing positions, which we believe are well set to withstand the economic impacts and do not view any of our holdings as exposed to a credit event.

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

 

 

Jun-20

June-19

Liontrust GF Sustainable Future European Corporate Bond A5 Acc

-1.0

4.3

iBoxx Euro Corporate All Maturities Index

-0.5

4.8

 

*Source: Financial Express, as at 30.06.2020, in euros, total return (net of fees and income reinvested). Discrete data is not available for five full 12-month periods due to the launch date of the portfolio

 

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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. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well-regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

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, July 16, 2020, 3:28 PM