Liontrust GF Strategic Bond Fund

February 2020 review

The Liontrust GF Strategic Bond Fund returned 0.0%* in US dollar terms in February.

 

Market backdrop

 

The vast majority of economic data has shown a strong start to the year with activity recovering from the trade war headwinds in 2019. It is worth bearing in mind that there was a much improved growth outlook prior to the spread of COVID-19. The economic impact of this strain of coronavirus will undoubtedly now be large in Q1 2020, whether it is significantly detrimental to global growth for the full year depends on myriad factors; this debate in the markets is framed around whether we will witness a “V-shaped” recovery. At one end of the spectrum, if the vaccination that is being worked on by Gilead and others proves to be effective, this crisis will obviously pass very quickly. Financial markets are clearly worried about the other extreme scenario where COVID-19 becomes a global pandemic.

There would, of course, be a policy reaction to aid economies in the event of a sustained pandemic. Examining the monetary side of the equation first, some commentators are clamouring for pre-emptive rate cuts and the markets are already discounting three to four US rate cuts this year from the Federal Reserve. Fed chair Jerome Powell’s statement on the 28th noting the “evolving risks” to the economy from the virus has been interpreted as a material change;

Wall Street consensus is that there will now be a cut at the March and April FOMC meetings.

Outside of providing a brief fillip for risk markets, we believe rate cuts will have very low efficacy and in some jurisdictions actually be counterproductive. The problem is not one of financing long term projects, it is about tiding businesses through these tough times.

A far more effective approach would be to offer the banking system a temporary large liquidity boost. For most large companies the COVID-19 crisis is just creating a P&L hit and not an existential threat. However, some companies could suffer a large working capital problem and will need extra cash to tide them through until demand, or supply of things such as production components, returns. If the banking system can provide viable companies with the temporary additional funding they require, then the upward leg of the “V” is likely to be sooner and sharper.

Fiscal stimulus will have far greater efficacy. For some politicians this crisis will provide a Trojan horse to boost spending. Across Asia and most of Europe one should expect government cheques to be more forthcoming over the next few months. Even Germany has discussed that, in extremis, the black line of a balanced budget could be sacrificed; this would take a two thirds majority so don’t hold your breath but do expect a reduced fiscal surplus.

Currently our central case is for a short bout of stagflation. Activity is falling and the price of goods will be bid up due to shortages created by a combination of hoarding and supply chain disruption. Looking out to later in 2020 the negative impacts will abate provided that supply chains restart and consumption holds up. Hopefully, by the time the weaker economic data for Q1 and Q2 is released the worst of the virus will have passed.

Rates

Clearly, with the benefit of hindsight, one should have been limit long rates risk as the flight to quality took some bond yields to all-time lows. The Fund did have enough duration, approximately 2.75 years, to provide a good mitigation to the generic credit widening seen throughout the market. More importantly, the conventional rates risk the Fund had was in all the right places. Our long-held preference for US duration compared to that in Europe was beneficial as the spread between the two continents compressed further. Other quality sovereigns owned - New Zealand and Norway – witnessed even larger rallies.

The flight to quality has created a “bull steepener” in the bond market; yields have fallen and shorter-dated bonds have seen larger yield drops than their long-dated cousins. This is logical as, despite our protestations, there may well be monetary stimulus which supports shorter tenors but helps to boost growth and inflation, thereby hurting the long end of the bond markets. Our curve positioning was beneficial, trading the 30-year US Treasury future.

The one quality rates holding in the Fund that fared relatively badly was TIPS (Treasury Inflation Protected Securities) which failed to keep pace with the rally in conventional bonds (i.e. inflation breakevens tightened).  We added to TIPS during the month as breakevens of 1.5% are incredibly cheap compared to US CPI in the 2.2%-2.3% range. Although the headline duration of the Fund has stayed the same at around 2.75 years, the underlying constituents are lower beta. Furthermore, we also switched some duration exposure into Japan, a relative laggard and classic lower beta sovereign bond market.

Allocation

 

We entered the COVID-19 crisis with a relatively defensive credit positioning. The main change over February has been averaging in to more high yield risk using the iTraxx Xover Credit Default Swap (CDS) index. The overall high yield holding is now a little over 20%, split reasonably evenly between physical bonds and the CDS overlay. Over the next few weeks we are seeking to buy more physical high yield bonds as the market dislocation should create decent opportunities.

In the investment grade arena, it is worth noting that the Fund owns no Additional Tier 1, corporate hybrids, emerging market corporates or sovereigns. We also have had a preference for corporate credit compared to financials.  Although the Fund has not been immune from credit spread widening we are delighted we did not spend the previous few months chasing risk in a hot market.

Additionally, the Fund had an overlay in place using CDS indices that provided a handful of basis points of alpha during the spread widening. We were long risk iTraxx Main (also known as iTraxx Europe) and short risk iTraxx Senior Financials; the spread between the two widened as systemic risk increased and we banked the profit on the last trading day in February. When valuations were expensive it made sense to buy cheap portfolio insurance, now that credit is cheaper we are gradually increasing weightings.

Selection

 

In the spirit of full disclosure, we did have a brief foray into a corporate hybrid as AT&T issued a particularly cheap deal in euros; we made just over 2 points profit and sold it a week later. Staying with AT&T, we switched the floating rate note (FRN) into a cheap bond denominated in sterling. The holding in Amgen’s FRN was also sold, on this occasion to fund the purchase of a 10-year maturity US Dollar bond from the same issuer.

A couple of more defensive euro-denominated new issues priced with a reasonable credit spread. We bought Deutsche Bahn, however received a mediocre allocation and sold it a fortnight later at a small profit. Single A-rated Ausnet, a regional Australian utility, offered a spread premium due to the European markets’ lesser knowledge of the issuer; we took advantage of this to establish a position in what we view as a core defensive credit holding. 

Finally, Santander has tendered for US$600m out of $1.5bn on one of its short-dated bonds which is owned by the Fund. The tender is at a decent level, which is a pleasant surprise with the issuer not renowned for their generosity, so hopefully a large percentage of the Fund’s bonds will be selected. This would only add a couple of basis points to the Fund, but generating incremental performance from a short-dated bond all adds up over time.

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

 

 

Dec-19

Liontrust GF Strategic Bond B5 Acc

10.2

 

*Source Financial Express, Morningstar, as at 29.02.19, total return, B5 share class.

 

**Source Financial Express, Morningstar, as at 31.12.19, total return, B5 share 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.

Tuesday, March 3, 2020, 11:54 AM