Liontrust GF Strategic Bond Fund

September 2020 review

The Liontrust GF Strategic Bond Fund returned -0.4%* in US dollar terms in September. The average return from the EAA Fund Global Flexible Bond (Morningstar) sector, the Fund’s reference sector, was -0.3%.

 

Market backdrop

 

Global economic recovery has advanced well compared with what had been expected earlier this year. We have a long road to recovery; a road that is winding and bumpy thanks to a combination of politics and Covid-19. Our recent strategy piece continues to be relevant in that respect.

Investors had worries aplenty as the quarter drew to a close: equity valuations looked challenging, corporate bond supply increased, and concerns grew that further US fiscal stimulus would be delayed until after the US election. Overall, risk assets had their poorest month since March.

We mentioned the change of strategy outlined by the Federal Reserve – to move to a symmetrical inflation target. As expected, that has had some implication for bond markets. The US bond market in particular has fallen in value and to a greater extent than international peers. Specifically, long-dated US bonds fell in value. Investors remain certain that a further US fiscal stimulus package will materialise and fear the Fed may be successful hitting its inflation target.

We have long held US Treasury Inflation Protected Securities (TIPS). This has provided the portfolio with a degree of protection in recent days. Also, we switched from 10-year TIPS into their 30-year equivalent.

Mean Reversion, Curve Plays & Portfolio Construction

We thought it worth a few words on interest rate curves and how we have been playing them. First off, we don’t like government bonds. Since launch, our portfolio has had less than half the interest rate risk of the global bond market. Between central banks, QE and investors seeking safe havens, government bonds have performed very well in recent years.


We do have a number of levers we can pull to try to make money, and not just the big one of market direction. Two of those levers have been inflation-linked securities (the TIPS mentioned above) and interest rate curves. We can use these levers to construct a portfolio that can do OK, even if our overall beta – our directional exposure – is less than that of others.

Generally speaking, long-dated bonds do better when bond markets are rallying. We’d term that a bull flattening – where all yields fall, but longer ones fall more than short ones. TIPs and similar securities tend to move in the opposite direction: bonds rally as inflation expectations fall so instruments like TIPs are in less demand.

What have we done recently? Firstly, we owned a reasonable amount of long-dated US bonds and not much in shorter dates. This gave us some protection: if we were wrong and bond markets rallied, then we’d get a better pay off owning those long bonds than the short ones.

Second, we switched our 10-year TIPs into longer dates, expecting mean reversion. 10-year TIPs had gapped higher since March and the extra inflation compensation to 30-year TIPs declined to zero, back to pre-crisis levels. But we believed Powell’s new inflation mantra boosted the attractiveness of those very long-dated TIPS and, at the same time, reduced the attractiveness of all US bonds, especially long-dated ones (i.e. a bear steepener).

US treasury inflation

As you can see, the spread between 10-year and 30-year TIPs has widened again. So, although we do continue to own some long-dated US Treasuries, the holding is in 30-year TIPs, which have rallied relative to conventional Treasuries and their 10-year equivalent. This might all sound a bit complicated. In reality, it’s nothing more than mean reversion/value process helping construct a portfolio.

Rates

There really isn’t much change from last month and we retain the same overall shape. We do think long-dated bonds are vulnerable, hence the switch into TIPS. We should also note that all the fund duration in bonds over 10 years is either in corporate credit or in TIPS. We have no direct exposure to any government bond of longer than 10 years maturity. At the end of August, the Fund had 3 years’ duration, with a strong preference for the US. 

We remained modestly negative UK duration and modestly positive Europe (via investment grade bonds linked to Bunds) for two reasons:

  1. We expect some form of Brexit deal to be done. Gilts are vulnerable under that scenario but are arguably even more vulnerable in the medium term if the UK budget deficit balloons and the country loses the protection of big brother Europe.
  2. European rates are way too low. However, the prospect of any change to monetary policy is remote. So, although we hate doing it, owning some risk relative to the UK is a sensible hedge.

Allocation

We remained a little overweight credit – remember our neutral weights are around 50% investment grade and 20% high yield. At month end we were around 55% investment grade and 27% high yield. We had been lower, but equity market weakness (delay to fiscal stimulus, US politics and concerns the Nasdaq had flown too near the sun) spilled into high yield derivatives. That gave us the opportunity to add a little at levels not seen since early in the second quarter. The widening of credit spreads combined with becalmed sovereign yields to take portfolio returns modestly negative on the month.

Selection

We added a couple of investment grade “green” bonds to the portfolio as supply increased post the holiday season. We use MSCI as the external provider for our ESG scoring and target a portfolio average ESG rating of at least BBB. Green bonds aren’t really much cheaper than conventional ones any longer. However, demand for them has increased significantly so we are much less worried about secondary liquidity than we were a couple of years ago.

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

 

 

Sep-20

Sep-19

Liontrust GF Strategic Bond B5 Acc

6.4

7.4

EAA Fund Global Flexible Bond - USD Hedged

1.6

2.2

 

*Source Financial Express, as at 30.09.20, total return, B5 share class.

 

**Source Financial Express, as at 30.09.20, 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.

Wednesday, October 14, 2020, 12:35 PM