Liontrust Strategic Bond Fund

April 2020 review

The Liontrust Strategic Bond Fund returned 4.9%* in sterling terms in April, compared with the 4.0% average return from the IA Sterling Strategic Bond sector.

 

Market backdrop

For those that have lost loved ones during the Covid-19 crisis, the emotional scars will last for their whole lifetimes. For financial markets the extent of the economic scars will be a key determinant as lockdowns gradually ease around the globe. One of the main aims of the liquidity injections and fiscal packages is to avoid the destruction of business capacity; sadly, not all small companies will survive but if most do then the pace of the rebound will be far greater. With savings rates increasing there will be a wave of pent up demand from those that have maintained their incomes. 

In the meantime, we will witness more economic activity data from during the peak lockdown period. Spoiler alert: it will be dire. The US Q1 GDP figure of -4.8% only contained the early stages of the economic activity cessation so there is much worse to come. Obviously, the markets will not obsess over historic data provided forward looking surveys are more optimistic; but the upcoming US non-farm payrolls for April (due out on 8 May) is forecast to show the destruction of over 20m jobs. Following on from the recent cumulative initial jobless claims figures this 20m figure should not be a shock but it is still shocking in its scale and speed.

To do justice to a full analysis of the economic outlook, and the uncertainties surrounding it, will take a much higher word count than a monthly fund report contains; we will be writing a longer Global Fixed Income team quarterly investment strategy document in the next week or two to give much more detail on our outlook. The short version is that due to government stimuli the system survives, but a return to prior levels of nominal economic output will not occur until at least 2021. Against this backdrop we remain very constructive on the outlook for credit and the rest of this market commentary will focus upon developments during April in the developed markets’ credit markets. 

The US investment grade market had its best month for total returns in over 30 years. The spread of the market (using the ICE BAML US Corporate Bond Index) finished April at 213 basis points; this is a similar level to where spreads were during the European sovereign crisis in 2011/12 and still offers great long-term value. The index rules evict any companies whose credit rating has been cut to speculative grade levels (referred to in the press as “junk”, but I hate that word) at the end of each month, the most notable “fallen angel” in April being Pemex; without this rebalancing the spread would have been 224 basis points.

Beyond returns, an even more remarkable feature of the credit markets was the quantity of new issue supply; companies were keen to access the bond markets to add cash to their balance sheets and shore up liquidity.  Gross investment grade supply in the US dollar market in April was US$362.4bn, of which US$199.7bn emanated from corporate (non-financial) borrowers. The respective figures in the euro market were €86.3bn and €60.5bn, the latter representing the largest ever month for corporate issuance. Unlike the March cohort of issuance, the majority of the primary deals in April priced in line with where the secondary market in the companies’ existing bonds was trading. So, whilst the levels still offered compelling spreads there was no premium to entice investors to switch out of their existing holdings. 

The US high yield market also witnessed healthy levels of supply and there was even a couple of deals in Europe. Unlike their investment grade cousins, some high yield companies are still paying a large premium (relative to secondary market trading levels) to access liquidity. Unsurprisingly, the more challenged companies are those that are having to offer investors more. We are seeing increased incidences of companies having to offer secured debt to the bond markets in order to raise liquidity. Whilst this adds cash to the balance sheet it does have the negative impact of layering existing debt i.e. by inserting secured debt above bondholders in the capital structure the existing bonds become more subordinated which lowers recovery values should any default occur. 

This leads neatly onto one final statistic: there were 19 bankruptcies in the speculative grade markets in April. This was a record high count but with US$24bn bonds and US$12bn leveraged loans impacted, it did not make the top five months ever by value. The key to capturing the value in the credit markets remains investing in those companies that will survive and have a long term sustainable (in all senses) business model. I’m sure there is money to be made in the default minefield of distressed debt but we will stick to our unashamed quality bias throughout the ratings spectrum of the portfolio.

Rates

The Fund retained its low beta duration strategy, finishing April at 2.75 years. It was a good month for US inflation breakevens and during a market squeeze caused by a Federal Reserve buyback we reduced the position from 1.25 years to 1 year. With 10-year breakevens finishing the month at 1.05%, they offer great value and protection against the reflationary wave that will occur as authorities look to make up lost activity after the crisis. 

Having trimmed exposure to New Zealand in March, April’s further lurch lower in yields led us to completely exit this highly profitable position. Other cross market activity included one of our old favourites: going short Canada versus the US. We had also tactically reduced our European duration short relative to the US. The last couple of weeks has seen 20 basis points of relative underperformance of the US compared to Germany, so we will rotate duration exposure back stateside.

Allocation

After the significant purchases of credit during the market selloff, the Fund has not meaningfully altered its asset allocation in April. Investment grade exposure remains in the 55% area and the preference for US dollar denominated credit has been maintained due to the greater valuation opportunity there. High yield has recovered less than investment grade; with a 30% weighting (versus a 40% maximum), we are investing a larger proportion of the Fund’s risk budget to capture the upside here. Exposure is through 16% in physical holdings and 14% in the iTraxx Xover CDS (Credit Default Swap) index; the latter was used for implementation liquidity reasons. With liquidity slowly improving and the basis still negative (CDS spreads are tighter than those on corresponding bonds), we will seek to increase the proportion of physical holdings. 

Selection

There was a strong rebound in the prices of the debt issued by those companies that are deemed survivors during the economic collapse caused by the Covid19 crisis. US healthcare companies aiding performance included Danaher and Eli Lilly; the latter actually guided up profit expectations during the month. On the financials front, AIG and MetLife both rallied strongly with Barclays and Santander also being notable contributors to performance during April. Two tobacco holdings, namely BATS and Altria, also saw a significant rally in their credit spreads. On the high yield front, Neptune Energy - one of the Fund’s riskiest bonds – began its recovery with further to go; Donald has written on this recently.  Allfunds is bouncing back towards par from a price level in the mid-80s (cents in the Euro) at which exactly zero bonds changed hands to the best of our knowledge; there were no offers when we tried to buy some.

Trading activity was biased toward the secondary markets due to the lack of premium being offered in new issues. One attractive core holding that was bought in the primary process was Rabobank senior debt. Phoenix Life came with a dated subordinated deal at simply the wrong price; our allocation was poor with the deal 7x oversubscribed, so we sold the bonds at a 4% higher price within a couple of days. Senior debt in US dollars was purchased in Credit Suisse, which had been a relative market laggard, as well as a dated lower tier 2 bond from Morgan Stanley. The Fund’s weighting to the banking sector remains comparatively low at 15% as there will be a lot more supply as banks’ balance sheets rapidly expand. we are well placed to take advantage of any cheap issuance that arises.


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

 

Mar-20

Liontrust Strategic Bond B Acc

-3.0

IA Sterling Strategic Bond

-1.3

Quartile

3

*Source: Financial Express, as at 30.04.2020, accumulation B share class, total return (net of fees and income reinvested.

**Source: Financial Express, as at 31.03.2020, accumulation B share class, total return (net of fees and income reinvested. 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.

Thursday, May 7, 2020, 2:25 PM