Liontrust GF SF European Corporate Bond Fund

Q4 2019 review

The Fund returned 0.5% in euro terms over the quarter, outperforming the iBoxx Euro Corporate All Maturities Index’s -0.5%*

 

Our underweight interest rate risk and overweight credit beta positions both contributed to the strong relative performance over the quarter, as trade developments between the US and China, ongoing support from central banks and the Conservative victory in the UK General Election provided a favourable market backdrop.

Similar to the previous quarter, corporate bonds outperformed government and the portfolio benefitted from its overweight credit position. Stock selection and overweight exposure to insurers and banks had the largest positive impact on performance, particularly via the fund’s higher-beta subordinated bond holdings as their credit spreads tightened in the risk-on environment.

Our other largest overweights in utilities and telecommunications were also positive, offering higher levels of spread duration on relative to the broader market. 

Against this, our overweight position to Bunds was a detractor, underperforming amid the risk-on tone.

In contrast to the rest of 2019, the fund’s underweight interest rate risk position also contributed positively, driven by the rise in government bond yields across developed markets. German 10-year bund yields rose 39 basis points to end the year at -0.19%, while UK 10-year Gilt yields climbed by over 30bps and US 10-year Treasury yields by 25bps to end the year at 0.82% and 1.92% respectively.

In October, UK Prime Minister Boris Johnson surprised markets by delivering on a Brexit deal but was forced to extend the deadline until the end of January 2020, after being unable to pass the new deal through Parliament. The government managed to pass a bill for a General Election for December with Johnson hoping to win a majority in order to progress with his Brexit deal.

The resulting large majority for the Conservative party was positively received by financial markets, with parliament passing the European Union Withdrawal Bill in the following days. UK assets responded positively to these developments, particularly domestic banks and utility companies given Labour’s stated policy of nationalisation for the latter. Sterling also strengthened on the back of the election result.

Despite the result, there remains much to be done during the transition phase and with Johnson maintaining the UK would not seek an extension to the end 2020 deadline, there is still a risk of a cliff-edge departure from the European Union at the end of the year.

In the US, there was positive news on the trade picture with China, with the announcement of a phase one deal stopping further tariffs due in December. In addition, President Trump announced there would be no tariff increases on the European automotive sector.

Meanwhile, the Federal Reserve announced a further 25 basis point rate reduction in Q4, making it three cuts in 2019. This was in response to softening economic data, particularly in relation to manufacturing and consumer confidence. Commenting at the time, Fed Chair Jerome Powell signalled the Bank had finished its monetary easing, subject to economic data developments.

Towards the end of the quarter, economic surveys improved and coupled with the positive trade developments, this resulted in a steepening of the US government bond yield curve. This has helped alleviate fears over a US recession, which increased earlier in 2019 due to the inversion in the curve.

In the UK, the Monetary Policy Committee kept interest rates on hold, although two members voted in favour of a cut. Economic data has slowed but the MPC was expecting an improvement following positive Brexit developments.

Finally, the European Central Bank restarted its Corporate Sector Purchase Programme in an attempt to stimulate the eurozone economy. New ECB president Christine Lagarde echoed what her predecessor Mario Draghi had advocated, that fiscal spending is required further to stimulate the economy, and called for an increase in government spending across the eurozone.

Overall, there has been a sharp turnaround from twelve months ago, with central banks pivoting from their tightening stance to injecting monetary policy stimulus to support growth.

There was a strong flow of issuance in the final quarter of the year and we took advantage by participating in new bonds from Orsted. This is a high-quality sustainable company and currently one of the largest green energy developers in the world, which combines with robust credit fundamentals to make it an attractive investment proposition.

We also added another new name in the shape of Logicor. a real estate business focused on warehouses and logistics properties. The company is set to benefit from continued favourable supply and demand dynamics in the logistics space, driven by the ongoing expansion in e-commerce.

Against these new additions, we took advantage of strong relative performance in some of the portfolio’s subordinated holdings, where spreads have compressed to historic lows in relation to senior parts of their capital structure. Hybrid holdings from companies such as EDP and Iberdrola were all reduced over the quarter as we lowered overall credit exposure.

We also exited our position in Virgin Media. The potential for M&A in order to add scale to Virgin Media’s mobile business has increased significantly, with parent company Liberty Global flush with cash following the sale of its central and eastern European assets to Vodafone earlier in the year. Combined with the well-known availability of some UK mobile assets, and strong performance delivered by the bonds year to date, we viewed the risk-return trade-off as no longer attractive and exited our position.

Elsewhere, we reduced the size of the duration short over the quarter from -2.5 to -1.5 years, with the US position taken back to flat and the short to Europe cut to -1.5 years on relative valuation grounds.

Looking forward, we remain firm in our belief that the macro backdrop for credit markets is 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 some Brexit uncertainty and trade war concerns remain. As such, we retain an underweight position to interest rate risk and will continue to actively manage this allocation. 

 

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

 

 

Dec-19

Liontrust GF Sustainable Future European Corporate Bond A5 Acc

7.3

iBoxx Euro Corporate All Maturities Index

6.3

 

Discrete data is not available for five full 12 month periods due to the launch date of the portfolio. *Source: Financial Express, as at 31.12.2019, in euros, total return (net of fees and income reinvested).

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.

Tuesday, January 21, 2020, 10:54 AM