Liontrust Monthly Income Bond Fund

Q4 2020 review

The Fund returned 4.2% over the quarter, outperforming the IA Sterling Corporate Bond sector average of 3.3% (the comparator benchmark) and 3.9% from the iBoxx Sterling Corporates 5-15 Years Index (the target benchmark)*. 


On the macro front, the final quarter of the year was dominated by positive news regarding vaccine developments, with hopes of a return to normality overshadowing record high infection rates, rising hospitalisations and tightening lockdown restrictions towards the end of the period. This drove an acceleration in the rally across risk assets, including credit, expanding to more economically and Covid-19 sensitive sectors that had previously lagged through the recovery.

 

Credit markets saw spreads tighten amid this risk-on tone, further supported by continued strong technicals including low levels of issuance, enhanced monetary and fiscal support packages and rising demand for yield. Against such a constructive backdrop, the Fund outperformed its benchmarks, driven by the overweight position in credit – via a combination of stock selection and sector allocation as corporate bonds outperformed government counterparts over the period.

We saw a particularly strong contribution from our exposure to the banking sector, as our subordinated holdings benefited from the risk-on environment: our USD-denominated holdings from the combination of positive vaccine news and Joe Biden’s presidential election victory, and our UK banks from news of a Brexit deal. Performance was further bolstered by tender offers for two of our holdings in Lloyds perpetual bonds, with the offers well above market levels to entice holders to participate.

While banks proved the major factor, overweight positions in telecommunications and insurance were also positive, particularly our allocations to US company AT&T and USD-denominated bonds. Vaccine news also resulted in particularly strong performance from some of our more Covid-exposed names, which we had added/topped-up on weakness earlier this year, such as student accommodation provider Unite Group and transport provider National Express. These contributions more than offset the drag on performance from our more defensive allocations to gilts and CDS indices, as well as underweights to more cyclical sectors such as industrials, which obviously also did well amid vaccine-fuelled optimism.

Strong returns from our credit portfolio also far outweighed the negative contribution from the Fund’s short duration position, as government bond yields diverged greatly heading into the year end. US 10-year Treasury yields rose 23 basis points, ending 2020 at 0.91%, again driven by vaccine optimism and Biden’s Presidential victory. Meanwhile UK 10-year gilt yields finished the period broadly unchanged at 0.20%, as vaccine optimism was tempered by lingering Brexit uncertainty and accelerating Covid-19 infections and stricter lockdown measures. In Europe, German 10-year Bund yields fell five basis points to -0.58%, curbed by the European Central Bank’s announcement of an expanded quantitative easing package

As highlighted above, November’s vaccine announcements were the principal driver for markets over the quarter, as each of the inoculations being developed by Pfizer-BioNTech, Moderna and Oxford-AstraZeneca proved highly effective in protecting against Covid-19. The vaccines have also cleared the challenge of regulatory approval, granted to at least one of these in the UK, US and EU, leading to optimism the end of the pandemic is in sight. However, there remain considerable logistical hurdles to overcome regarding the manufacture, distribution and administration of these vaccines on a global scale, particularly given cold storage requirements.

In the meantime, the situation has deteriorated further, as Covid-19 cases have accelerated once more, reaching record highs since the start of the pandemic and ICU occupancy following suit. This has been attributed to new strains of the virus, notably in the UK, with the mutations seemingly more contagious although not believed to be more dangerous. These developments compelled governments to impose stricter lockdown measures in order to slow the spread, which will likely see economic activity suffer into Q1 2021.

In the US, investor sentiment was further boosted following Biden’s victory in the presidential election, with a less combative tenure than that of his predecessor widely anticipated. Given the Senate is likely to be divided with no clear majority for either side, the scope for aggressive reform is limited and that should result in a relatively benign policy environment, which is supportive for both credit and broader risk assets. Biden’s victory also paved the way for Congress to approve a much needed $900 billion stimulus package, extending and expanding many of the programmes introduced earlier in the pandemic and providing additional support for economic recovery. Meanwhile, the Fed reiterated its commitment to supportive monetary policy, keeping interest rates unchanged and continuing with its quantitative easing (QE) programme until sufficient progress has been made towards employment and price stability goals.

The Bank of England also kept interest rates on hold, although rumours of a potential move to negative rates continued throughout the period. The central bank was another to expand its asset purchase program by a further £150 billion, to £875 billion in total, to support recovery, with additional support in the shape of fiscal stimulus measures, again extending and expanding existing Covid response programmes.

Despite much posturing from both sides in the build up to the 31 December deadline, the UK and Europe finally agreed a Brexit trade deal on Christmas Eve, which should allow markets and sterling to start 2021 on firmer footing and companies to plan ahead and invest for the future. Concerns around a no deal, with fishing rights apparently the sticking point, gnawed at sentiment for much of the quarter and after weeks of talk about an ‘Australia-style’ deal, it took a Canada-style arrangement to end the UK’s 47 years as part of the European Union. While there will obviously be a transition period as the UK diverges from the world’s largest trading bloc, the hope is that the country can finally move on to other things, whatever challenges we may face as a newly ‘sovereign’ nation – and top of the pile is obviously navigating our way out of Covid-19.

Elsewhere, European leaders finally agreed an unprecedented €1.8 trillion support package, including the €750 billion recovery fund, which had been the stumbling block in previous discussions. As part of the agreement, a sizable portion of these funds must be spent on sustainable and green projects, supporting the decision to accelerate the carbon emissions reduction goal to address the climate emergency. Monetary policy remains highly supportive, with the European Central Bank deciding to maintain interest rates and expand the Pandemic Emergency Purchase Program to €1.85 trillion and extend it until at least March 2022, as well as boosting several other Covid support measures, including TLTRO.

Over the final quarter of the year, portfolio activity was relatively muted. New issuance levels remained low throughout the period, although we did participate in a hybrid issue from National Express, which offered an attractive yield pick-up versus the company’s senior bonds. While the business has been heavily impacted by Covid-19, a combination of management actions, the high percentage of contractual business and using government support schemes means it is well positioned to benefit when social restrictions are lifted.

Outside of this, our activity was largely limited to risk reduction trades as we looked to capitalise on recent strong performance. We reduced exposure to subordinated bonds from Coventry and Nationwide Building Societies following particularly strong returns, re-investing the proceeds in bonds higher up the capital structure from names such as Barclays. We also rotated out of our holding in Direct Line RT1 bonds, again recycling the proceeds into bonds higher up the capital structure in favoured insurance names such as Rothesay Life and Legal & General on relative value grounds. We reduced exposure to M&G, switching into USD-denominated bonds from Axa and Barclays on relative value grounds.

As highlighted, we participated in a tender and exchange offer from Lloyds, switching out of our legacy perpetual bonds at an attractive above-market level, and partially exchanging into a new subordinated issue at a re-entry point offering good value versus existing secondary bonds in the name. There was a second standalone tender offer for another of our Lloyds legacy USD perpetual bond positions late in the quarter, and we temporarily reinvested the proceeds into gilts to give us flexibility to exploit opportunities in the new year.

Elsewhere, we elected to close our remaining CDS index position early in the period, closing our short to the US high yield market in line with our constructive view on credit at present.

We increased the size of our duration short to 4.5 years over Q4, which is currently expressed through a 3.5 year short to the UK and one year to the German market. We increased the UK short following the move lower in yields on Brexit uncertainty and tightening of lockdown measures, with yields having trended back down to the lower end of our expected 0.2%-0.8% range.

Many of the challenges of 2020 are clearly set to continue into 2021, with rising Covid infection rates and the re-introduction of national lockdowns inevitably hampering global economic recovery. However, markets continue to look through near-term volatility, with companies better prepared to manage these difficulties and vaccine rollouts taking shape, alongside reduced political headwinds following the US presidential election and confirmation of a Brexit trade agreement.

We remain constructive on investment grade credit, as we expect company focus to continue shifting towards improving fundamentals. As expected, corporate fundamentals have deteriorated further, fuelled by the collapse in earnings combined with growing debt issuance, but within investment grade, issuance has predominantly been defensive in nature to bolster liquidity buffers. This is reflected in high levels of cash on company balance sheets, keeping net leverage levels broadly flat, while we saw issuance drop off towards the end of the year as expected, with liquidity now at robust levels.

While further deterioration is likely in the near term as more periods of depressed earnings are factored into leverage calculations, we continue to expect that, having weathered the initial storm, focus will shift towards creditor-friendly debt reduction and balance sheet repair, supported by a rebound in corporate earnings. Credit should also continue to be buoyed by strong technicals, with expanded central bank corporate bond purchase programs, low supply given robust liquidity, extended fiscal support measures, and rising demand for corporate bonds as a rare source of yield for investors.

We remain committed to our high-quality portfolio, which we believe is well positioned to withstand the economic impacts as a result of the pandemic, and do not view any of our holdings as exposed to a credit event. From a sector perspective, we continue to favour insurance, telecoms and banks, with cyclical non-financials generally over-owned, expensive and/or more heavily exposed to Covid-related uncertainty.

Our outlook regarding interest rates also remains relatively unchanged, with government bonds still vulnerable to unprecedented supply and reflation risks. Moreover, with government bond yields continuing to be close to zero (or below in several countries, including Germany), they offer limited ability to dampen portfolio volatility and actually provide meaningful downside risk during bouts of market weakness or volatility, supporting our longstanding short duration position.

To reiterate our view, we expect 10-year gilt yields to remain in a relatively tight trading range of between 0.2% and 0.8%, as the Bank of England continues to use QE to limit any rises in gilt yields while remaining reluctant to introduce negative rates in the near-term. Given 10-year gilt yields are currently languishing towards the lower end of this range, we believe there is scope for them to rise modestly as the magnitude of fiscal impact on gilt issuance hits the market, and we will look to increase duration in the portfolio as yields trend towards the higher end of our range.

Longer term, we believe there is a risk gilt yields rise and/or the curve steepens without continued buying from the Bank of England purchase program, combined with rising inflation and strengthening economic recovery, again supporting our preference to retain a short position.

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

 

Dec-20

Dec-19

Dec-18

Dec-17

Dec-16

Liontrust Monthly Income Bond B Gr Inc

5.5

9.4

-3.0

8.9

9.4

iBoxx Sterling Corporates 5-15 years

8.6

10.7

-1.7

5.7

10.8

IA Sterling Corporate Bond

7.8

9.5

-2.2

5.1

9.1

Quartile

4

3

4

1

2

 

*Source: Financial Express, as at 31.12.20, 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.

Wednesday, January 20, 2021, 3:59 PM