Liontrust GF SF European Corporate Bond Fund

Q3 2019 review

The Fund returned 1.1% in euro terms over the quarter, slightly lagging the iBoxx Euro Corporate All Maturities Index’s 1.3%*. 

 

The period proved one of contrasting fortunes. Overall, the summer months saw a significant sell-off in bonds, as a combination of escalating US-China trade tensions, deteriorating global economic growth, and heightened Brexit uncertainty saw markets adopt a risk-off tone. The changing seasons brought a change in investor attitudes however and further monetary stimulus from central banks boosted investor confidence in September, with risk assets rebounding strongly.

As in Q2, corporate bonds outperformed government over the period and the fund benefitted from its overweight credit position. This was predominantly driven by strong sector allocation and stock selection, particularly within our largest sector weightings to banks, utilities, telecoms and insurance.

The portfolio saw strong outperformance from its higher beta subordinated holdings, in names including Swiss Re, National Grid and Assicurazioni Generali, as credit spreads tightened further over the period. It also profited from longer spread duration assets, in names such as Telecom Italia and Snam, which benefitted from falling government bond yields.

Despite a sharp sell-off in September following the announcement of renewed monetary stimulus efforts, Government bond yields fell markedly over the quarter as investors grew increasingly concerned by the macro backdrop. This led to underperformance from the portfolio’s underweight interest rate risk position. German 10-year Bund yields continued to set new records, dipping as low as -0.72% before rallying to finish the period at -0.58%, falling 25 basis points over the quarter. UK 10-year Gilt yields fell 35bps to finish the period at 0.48%, having set a new all-time low of 0.40% in Q3. US 10-year Treasury yields fared little better, falling 34bps to reach 1.67%.

Although the portfolio’s underweight to interest rate risk was a detractor over the period, we did benefit from active management of the market allocation. The decision to maintain the position predominantly via the German market, where yields did not fall as sharply as in the US and the UK, proved positive. Meanwhile, our call to rotate some of the short position out of the German market, increasing the position to the US during the period, was also beneficial as the sharp rise in US yields in September outstripped the German market.

Q3 was a busy period on the policy front, with two rate cuts from the Federal Reserve and the European Central Bank also reducing rates and committing to open-ended quantitative easing from November. The Fed’s first cut in 11 years was back in July but the 0.25% reduction was actually less dovish than anticipated, with some investors expecting a 50bps cut and Chair Jerome Powell emphasising this would not be the first of many.

In fact, continued weakness in economic data and ongoing pressure from President Trump saw another 25 basis point cut just two months later: again however, while widely anticipated by the market, the associated commentary was more hawkish than expected. Growing divisions appear to be emerging within the Federal Open Market Committee itself. While seven of the 10 FOMC members voted for the September cut, two dissenters argued not to cut at all and one called for a 50-basis-point reduction. Such disagreement is unusual and make it difficult for Fed-watchers trying to predict which way policy will go.

Moving across the Atlantic, the European Central Bank opted not to cut rates in July but announced a stimulus package to come in September. This dovish stance was reinforced by the nomination of Christine Lagarde to take over the ECB presidency from Mario Draghi in November.

As widely predicted, the ECB cut its deposit rate to a record low -0.5% from -0.4% in September and pledged to restart bond purchases of 20 billion euros a month from November. While this was lower than market expectations of around €40 billion, the programme was left open ended and is set to continue until the bank has achieved its inflation target. Draghi also implored European economies to provide additional fiscal stimulus in order to further support growth.

Coming finally to the UK, Brexit continues to dominate and we saw Boris Johnson secure a comfortable victory in the Conservative leadership race in July to become Prime Minister. The result renewed concerns of a no-deal, as he pledged to ensure the UK leaves the EU with or without a deal by the 31 October deadline.

Adding to the controversy, Johnson announced plans to prorogue Parliament, with the intention to shut down for an unprecedented five weeks and reconvene following a Queen's speech on 14 October. This was widely seen as an attempt to stall anti-Brexit activity and, in September, the Supreme Court ruled prorogation unlawful and MPs were called back with immediate effect. 

Meanwhile, the back and forth continues: Johnson continues to meet European leaders while reiterating his message on leaving come what may on 31 October but to prevent a no-deal, Parliament has passed legislation forcing him to ask for a further extension if there is nothing in place by 19 October. Amid all this, the Bank of England kept rates on hold over the quarter, saying that the ‘entrenched uncertainty’ caused by Brexit and trade will keep rates lower for longer and could prompt a cut in short order.

Given the political uncertainty engulfing the UK, it is easy to overlook the rising political uncertainty elsewhere. In the US there are increasing calls for impeachment proceedings against President Trump concerning alleged contact with Ukraine regarding former Vice-President and prospective 2020 Democratic Party presidential candidate Joe Biden. In continental Europe meanwhile, Italy’s government collapsed, with a seemingly equally fragile new coalition formed between the Five Star and Democratic Parties.

Against this backdrop, there was moderate portfolio activity over the period.

Following a relatively muted summer, European corporates came back to market with full force in September, taking advantage of the low funding costs and reintroduction of quantitative easing to register one of the largest ever months for issuance. The Fund took advantage of this, opting to rotate out of existing bonds as well as new additions to exploit the new issue premia on offer.

New issues generally came with longer maturities as corporates sought to lock in the lower cost of debt for longer. As a result, we rotated out of shorter-dated bonds in names including BT, Snam, Verizon and Kerry Group, picking up the higher spreads on offer further out on the curve as well as new issue premia.

We increased our exposure to National Grid, adding the recently issued euro-denominated hybrid to our existing position in the sterling hybrid. The company is strongly exposed to our Improving the efficiency of energy use theme, operating the electricity and natural gas transmission and distribution networks in the UK. It also manages the energy system to help in the transition from high to low carbon, facilitating the shift to decentralised generation from renewable to energy battery storage.

There were also several relative value switches over the quarter, particularly within the banks and insurance sectors. While we continue to believe the sectors offer value opportunities, we elected to reduce our overall risk exposure following strong performance year to date. We did this by moving up the capital structure into higher seniority issues within names such as Standard Chartered and Allianz.

We also exploited some cross-currency opportunities, switching out of Euro into US Dollar bonds within Swiss Re, as the yield and credit spreads on offer in Europe continue to get squeezed, resulting in the relative pick-ups in the US becoming increasingly attractive once more.

While we maintained the portfolio’s duration position at 2.5 years short relative to the index over the period, the market allocation was actively managed throughout. Across July and August, we decided to rotate 0.75 years of our short from the German into the US market, driven by the inversion in the US yield curve as two-year Treasury yields rose above ten-year. This is widely believed to be a leading indicator of a recessionary environment but we continue to believe the risk of a US-led recession is low and hence the moves in the yield curve were unjustified.

Following a spike higher in US Treasury yields in September, and Brexit developments we believe moved the EU further away from a no-deal scenario, we opted to rotate 0.25 years of the short back into Germany from the US. This leaves the portfolio’s short duration position expressed via two years short to the German market and 0.5 years short to the US.

Looking forward, we remain firm in our belief that the macro backdrop for credit markets remains supportive. Notwithstanding the ongoing weakness in the global economy, we see three key factors that reinforce our belief.

First, despite the warning lights, the risk of a global and US recession is low. The service sector, the largest component of developed economies, remains strong, bolstered by low unemployment, positive real wages and robust housing markets.

Second, central banks continue to be supportive, with the US Federal Reserve cutting rates for the first time since 2008, and the ECB announcing a fresh stimulus package. Finally, corporate credit fundamentals remain relatively strong, particularly within investment grade, typified by high interest coverage ratios, stable net leverage ratios and low levels of defaults.

We also continue to believe government bonds are overvalued and expect yields to rise as macro concerns abate, although volatility is likely to persist over the short-term as Brexit uncertainty and trade war concerns remain. As such, we retain an underweight position to interest rate risk, spread across the UK, Germany and the US, and will continue to actively manage this allocation.

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

 

 

Sep-19

Liontrust GF Sustainable Future European Corporate Bond A5 Acc

4.9

iBoxx Euro Corporate All Maturities Index

6.2

 

Discrete data is not available for five full 12 month periods due to the launch date of the portfolio. *Source: Financial Express, as at 30.09.2019, in euros, total return (net of fees and income reinvested). Data correct as at 03.07.19.

 

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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.

Monday, October 21, 2019, 8:45 AM