Liontrust SF Corporate Bond Fund

Q1 2020 review

The Fund returned -7.8% over the quarter, underperforming the -5.6% return from the iBoxx Sterling Corporate All Maturities Index and the IA Sterling Corporate Bond sector average of -4.4%*.


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 the implementation of nationwide lockdowns in an attempt to contain the spread of the Coronavirus.

Negative returns on the portfolio were primarily driven by the overweight credit beta position 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 credit 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 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. The fund’s exposure to consumer names, such as National Express and Intercontinental Hotels also had a negative impact on performance over the quarter.

This weakness was partially offset by more defensive positions within the portfolio, particularly our allocation to UK gilts, an overweight to securitised names and strong stock selection within utilities. The portfolio also benefitted from its sustainability overlays, as we are underweight 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.

Overall, credit positioning has cost the fund around 140 basis points relative to the benchmark and, while disappointing, that is less than the outperformance generated from our credit exposure last year and should also be viewed in the context that recent events have unwound more than five years of corporate bond returns.

The portfolio’s underweight interest rate risk position also had a detrimental impact on performance over the period, 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%.

In a matter of weeks, we have seen credit markets enter unprecedented territory, both in terms of negative returns and record fund 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 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, going 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 £2500 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 packages to support business and households during these tough times.

Against such an unprecedented backdrop, there was modest portfolio activity over the first quarter. We have been tempted to increase beta but resisted this so far: markets remain volatile and the path of recovery is uncertain as the virus continues to spread, and, as stated, we have already seen some of our holdings rally off their lows.

Our main additions have been within sectors and holdings that 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 Lloyds Banking Group, 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 we 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 Pension Insurance Corporation to the portfolio, which offered strong credit fundamentals at attractive valuation levels.

The telecommunications industry has proved to be 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 our exposure through Verizon, a high-quality leading operator in the industry with strong credit fundamentals.

Elsewhere, we also added to the utilities sector, which delivered on its defensive reputation throughout the quarter as companies demonstrated low levels of cyclicality and resilient revenue streams. We added to Glas Cymru (Welsh water), a high-quality water utility services provider, at attractive valuations following a new issue.

Finally, we added to Segro, an A-rated property investment and development company specialising in logistics and warehouse properties. Its property portfolio is set to continue to benefit from the shift towards e-commerce, with the logistics space required considerably higher than that for traditional bricks and mortar retailers. We believe the shift towards e-commerce is only likely to accelerate as a result of Coronavirus but despite this, Segro suffered from a broader sell-off in the real-estate sector and offered an attractive valuation to add to our existing exposure.

Against these additions, we reduced our holding size across a number of names that had proved more resilient during the sell-off, such as GlaxoSmithKline and Deutsche Telekom.

We also closed our longstanding short duration position over the period, with the Fund now neutral relative to its benchmark. We took advantage of the sharp rise in government bond yields in mid-March, following the announcements of fiscal and monetary stimulus packages, to close the duration short and add protection against any renewed spell of bad news and dampen volatility.

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, we believe investment grade has suffered from a misconception that 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.

Rates markets have been challenging over recent weeks, initially providing some protection as risk assets fell but then selling off themselves as fiscal measures were announced, moving into a rare correlation with equities and credit. Our view is that the recently announced QE programs will limit any increase in government bond yields over the coming months, with the Bank of England announcing its aim is to use QE to limit yield rises and 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, we are maintaining duration at neutral but are looking to re-initiate a small underweight position near month-end levels, which we believe to be approaching the bottom end of the range.

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 proved 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 resilient against the economic downturn. As a counter to this, we continue to have no exposure to 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 Sustainable Future Corporate Bond 2 Inc

-1.4

2.6

2.6

12.3

-1.8

iBoxx Sterling Corporate All Maturities Index

0.0

4.1

1.6

10.7

0.1

IA Sterling Corporate Bond sector average

0.8

3.0

1.7

8.9

-1.0

Quartile

4

3

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, 3:51 PM