Liontrust Monthly Income Bond Fund

Q1 2020 review

The Fund returned -8.6%% over the quarter, underperforming the -4.4% average return from the IA Sterling Corporate Bond sector and -5.9% from the iBoxx Sterling Corporates 5-15 Years Index*

 

The first quarter of 2020 has been dominated by the Coronavirus pandemic, which has resulted in significant declines in valuations across global financial markets. This overshadowed a strong start to the year after initial signs suggested the global growth outlook was turning more positive. In a matter of weeks, the economic outlook has reversed sharply due to nationwide lockdowns in an attempt to contain the spread of the virus.

Negative returns on the portfolio were primarily driven by the underweight interest rate risk position, with government bond yields falling to record lows as investors sought safe havens. They did recover somewhat in the latter stages of the quarter, however, following central bank and government support packages: UK 10-year gilt yields fell 46 basis points (bps), from 0.81% to 0.35%, while US 10-year Treasury yields fell 125 bps to 0.67% and German 10-year bund yields 25 bps to -0.48%.

The fund’s overweight credit beta position also had a detrimental impact on performance as corporate bonds sold off aggressively amid rising concerns about the effects of widespread economic shutdowns on corporate profitability. These moves were further exacerbated by liquidity concerns arising from record fund outflows from the asset class and investment banks unwilling to take risk on their balance sheets, which resulted in indiscriminate selling of corporate bonds across all sectors.

Our favoured sectors, including banks, insurance and telecommunications, were all hit by selling pressure over the period. In banks, bonds across all parts of the capital structure fell amid indiscriminate weakness, with our higher-beta subordinated holdings particularly badly impacted. Insurers, meanwhile, saw widespread selling based on the perception they are more exposed to the financial impact of the virus than we believe is actually the case, while telecommunications took a hit as a higher-beta, liquid sector, with our longer-dated and US dollar bonds underperforming. However, it is worth noting we have already seen a significant rally in some of these bonds following the swathe of central bank and government stimulus announcements.

This weakness was partially offset by more defensive positions within the portfolio, particularly our long-standing short position to US and European high yield markets, exposure to UK gilts and an overweight allocation to securitised names.

In addition, the portfolio benefitted from being underweight a number of sectors that suffered as a result of the twin Coronavirus and oil price shocks. On the latter, the oil price dropped over 60% after OPEC failed to agree an extension on production cuts between major oil-producing countries despite demand being expected to suffer a significant decline as a result of the crisis. There was also positive contribution from our underweight to autos, as the already maligned sector’s malaise deepened in the face of the virus fallout.

Overall, credit positioning has cost the fund around 100 basis points relative to the benchmark and, while disappointing, that is less than the outperformance generated from our credit exposure last year and should be viewed in the context that recent events have unwound more than five years of corporate bond returns. Longer-term performance on the fund remains strong – as well as continuing to deliver one of the highest yields in the IA’s Sterling Corporate Bond sector.

We have seen credit markets enter unprecedented territory at an alarming rate, both in terms of negative returns and record outflows from the asset class, as financial markets struggled to assess the impact of countries closing their borders and nationwide lockdowns effectively shutting down most of the world’s largest economies. However, we are now beginning to see more positive signs emerging, with the spread of the virus slowing and an easing of the pressure on healthcare systems in those countries furthest into their respective lockdown periods.

These extraordinary times require extraordinary measures and the government and central bank action has been impressive in terms of its co-ordination, speed and scope. Markets have responded positively to these developments, showing signs of stabilisation towards the end of the period.

In terms of monetary policy, we have seen central banks deliver significant interest rate cuts, while also promising effectively unlimited quantitative easing (QE) to support market liquidity and keep government borrowing costs low amid unprecedented fiscal spending. The Federal Reserve cut rates sharply over the period, from 1.75% to 0.25% in March, while also announcing it is prepared to purchase Treasuries in “amounts needed to support smooth market functioning” and re-introducing a corporate credit programme to support investment grade debt.

While the European Central Bank did not opt to cut rates below the 0% level, it did announce the extension of existing QE, with the €750 billion Pandemic Emergency Purchase Programme (PEPP), while also removing some of the previous issuer constraints to provide additional flexibility in its support. As for the Bank of England, it materially cut interest rates by 65bps in total to 0.10%, while reintroducing and expanding its QE program by £200 billion. There was also a £300 billion liquidity package for banks, alongside more flexible collateral arrangements and reduced capital requirements.

On the fiscal side, governments around the world have announced extensive support packages for the businesses and individuals most impacted by the crisis. The US Senate passed a $2 trillion support bill, which equates to around 10% of the country’s 2019 GDP. Meanwhile, a raft of measures in the UK includes: a four-year funding scheme of at least 5% of bank loans to the real economy, guaranteeing 80% of staff salaries (up to £2,500 per month), companies being able to defer VAT payments to aid cashflows, and individuals offered mortgage holidays and enhanced welfare payments. In total, the aggregate of the measures announced is in excess of 50% of the UK’s GDP last year. Governments across Europe have followed suit with similar spending packages to support business and households during these tough times.

Against such an unprecedented backdrop, there was modest portfolio activity over the first quarter with markets volatile and the path of recovery uncertain as the virus continued to spread.

Our main additions have been within sectors and holdings we believe have been oversold but actually remain well placed to be resilient throughout the anticipated economic downturn.

We added to our banks exposure through Barclays, Nationwide Building Society and Coventry Building Society, which were among the worst-hit holdings in the portfolio. We continue to believe these banks remain well capitalised and will be significant beneficiaries of government and central bank support measures.

As stated, we feel the financial impact of Coronavirus on insurance companies will be significantly lower than the market is currently pricing in so also boosted our exposure to this sector. Insurance companies retain high credit quality and robust solvency positions and, as such, should also recover from these depressed valuations. We added to a number of existing names such as Legal and General and Aviva and also initiated a holding in Swiss Re, a global leader in the reinsurance industry with strong underlying credit fundamentals underpinned by its AA- credit rating.

The telecommunications industry has proved pivotal through this period, with countries in lockdown resulting in millions of people around the world being forced to work from home. Furthermore, the products and services these companies provide are allowing families and colleagues to stay connected through difficult times. The sector exhibits low cyclicality, with revenues predominantly subscription based, which should prove resilient through any economic downturn, while network quality and capacity has also been robust despite significantly increased daily volumes. We added to some existing holdings including Verizon, a high-quality leading operator in the industry, with strong credit fundamentals.

Against these additions, we reduced our allocation to gilts and disposed of several holdings including EDP, GlaxoSmithKline and Enterprise Inns, while also reducing our positions across a number of other names across the portfolio.

Rates markets have been challenging over the period, initially providing some protection as risk assets fell but then selling off themselves as fiscal measures were announced, moving into a rare positive correlation with equities and credit. We took advantage of the latter to lengthen duration to 4.25 years, reducing our short position to three years short relative to the benchmark. This increases protection against any renewed spell of bad news and should also dampen volatility. The short duration position is currently expressed via a 2.5 year short to the UK market and a 0.5 year short to the US.

MIBF has traditionally been a short duration portfolio and we intend to continue with that strategy until such time as government yields normalise. Our view is that the recently announced QE programs will limit any increase in government yields over the coming months, with the Bank of England announcing its aim is to use QE to limit any rises in gilt yields to avoid excessive government borrowing costs.

Alternatively, renewed bad news on the virus and/or hit to the economy will likely result in a government bond rally. Given the above, we believe government bond yields will remain rangebound, with returns from rates likely to be broadly similar for short, medium and long-dated funds over the medium term. As such, there is less reason to be short duration but if we see yields back to lows, we will look to add to the short position.

While the full extent of the economic impact will not be known until data releases in the second quarter, there was a staggering rise in initial unemployment figures in the US and already struggling European PMIs reached record lows. As a result, GDP growth is now expected to contract by around 15% in Q2, even across the countries taking the most aggressive steps to combat the virus. That exceeds what we saw at the beginning of the global financial crisis (GFC), but we believe the underlying conditions are very different this time and recent steps taken by central banks should mean this slowdown is shorter and recovery could be V-shaped within two or three months. While the decline is sharper and possibly deeper, the ultimate impact should therefore be less.

As for credit markets, our view is that investment grade has suffered from a misconception this is a financial crisis – and recent supportive measures are starting to address this, with the huge fiscal and monetary measures announced providing a floor from which markets and investment grade credit can consolidate and recover. Investors were generally long risk coming into 2020 on the back of improving macroeconomic data and, as such, we believe recent weakness is largely a volatility issue for investment grade – selected sectors and issuers are exposed but we would expect the backdrop to improve in due course.

High yield could be more exposed, however, with weaker financials undermining these companies’ ability to work through the sharp slowdown, combined with a lack of central bank support and an expected spike in default rates.

We continue to have confidence in our favoured sectors as markets normalise: banks are supported by governments and while revenues may be lower, that is more of an equity story than bonds; insurers, meanwhile, should recover as solvency levels are proven to be robust and the sector’s exposure to the virus is shown to be lower than feared. As for telecoms, with so many people working from home and depending on their services, the sector should prove to be resilient against the economic downturn. As a counter to this, we continue to have no exposure to the sectors most exposed to current uncertainty, namely autos, oil and gas and airlines, and minimal positions in consumer goods and services.

Our base case remains that government bond yields will remain rangebound over the coming months and from a credit perspective, the recovery should be led by our favoured underperforming sectors. We believe investment grade remains an attractive asset class and this a high quality-focused portfolio, with our sector positioning well placed to capture the recovery.

 

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

 

 

Mar-20

Mar-19

Mar-18

Mar-17

Mar-16

Liontrust Monthly Income Bond B Gr Inc

-3.0

1.1

4.2

13.3

-1.3

iBoxx Sterling Corporates 5-15 Years Index

-0.3

4.5

1.6

10.0

0.8

IA Sterling Corporate Bond

0.8

3.0

1.7

8.9

-1.0

Quartile

4

4

1

1

4

 

*Source: Financial Express, as at 31.03.20, primary share class, total return, net of fees and interest reinvested.

 

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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, April 16, 2020, 3:42 PM