Liontrust Strategic Bond Fund June 2021 review | Insights

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

The Liontrust Strategic Bond Fund returned 0.3%* in sterling terms in June. The average return from the IA Sterling Strategic Bond sector, the Fund’s comparator benchmark, was 0.8%.

Market backdrop

The bond market highlight for June was undoubtedly the Federal Reserve meeting on Wednesday 16^th. There was a significant shift in the dot plots, the FOMC members’ projections of where they envisage future interest rates will be. The median for 2023 now predicts two rate rises:

Federal Reservices Chart

It is no surprise that in the face of burgeoning inflation and a rapidly recovering US economy – even before further stimulus from an infrastructure package – emergency monetary policy stimulus will have to end sometime. With the Fed’s stated desire to make up for lost ground under Average Inflation Targeting, the hawkish tilt materialised sooner than market commentators were anticipating. However, the move merely validates what the front end of the curve had been pricing for a while and doesn’t guarantee that rate rises will occur. In my opinion, one should be forecasting an interest rate lift off in 2022 – other governors are likely to join the seven already predicting higher rates as the economy booms. Clearly this depends on a continued strong bounce back in employment.

The bond market reaction was a classic curve flattening with 5-year yields, depicted in green below, rising to price in more rate rises. Yields on 30-year bonds, the gold line, actually fell based on the expectation that the Fed will dampen down longer-term growth and inflation.

US 5s30s yield curve

The difference between the two tenors, measured in basis points on the right-hand axis of the graph, saw a dramatic move. This has led some economists to ask whether the Fed has made a policy mistake, but this is ludicrous as the Fed hasn’t even done anything yet. I continue to argue that a decade of monetary policy that is too loose has hugely impeded productivity growth: now that is a policy mistake!

It feels very early into the monetary cycle to start trying to predict where interest rates will peak. Certainly, with the amount of debt outstanding, rate rises have more marginal impact than in prior cycles. Set against this is our assertion that not all of the inflation we are witnessing is transitory in nature (see last month’s commentary); some is structural rather than just cyclical. We do not expect exceptionally loose monetary policy to be brought to an end; we do expect the real value of government debt to be eroded away by higher inflation. This is classic financial repression, enabling governments to improve their debt metrics over time in a system rigged by central banks. In bond markets, the free ride on beta is over and fund managers will now need to produce more alpha to generate positive real returns for investors.

Rates

Overall Fund duration finished June at 3 years^† having been down to 2.5-year intra-month. The geographical distribution is split reasonably evenly between dollar-bloc economies and European exposure. On the former, the US is the largest exposure and there is a small contribution from Australia. During June we took profits on the 5-year leg of the Canada versus US box trade as the spread approached zero. We then reinstated it at close to a 10-basis point differential. The Fund remains net short Canadian duration relative to the US.

Within Europe, we sold the second half of our successful long Switzerland versus BOBLs (the German 5-year government bond future) position. We retained the Fund’s Swedish 10-year bonds which have started to perform relatively well. The rest of the European duration is in the eurozone with a minimal contribution from the UK.

We continue to dislike the long end of the yield curve and believe that some of the large move in 5s30s (discussed above) was simply due to some investors getting stopped out of loss-making steepening positions. The Fund’s long-dated duration exposure is low, with futures used to hedge out the duration contribution from credit in US Dollars, but still above zero. We prefer the belly of the curve – bonds with 5 to 15-year maturities.

Allocation

Once again there was little change in the asset allocation during the month. We await more volatility in credit spreads to trigger a better buying opportunity. The Fund holds approximately 41.5% net in investment grade credit, split between 46.5% in physical holdings and a 5.0% risk-reducing overlay (we deem 50% to be a neutral weighting). High quality high yield retains its position as our favoured market within the fixed income universe. The Fund has a 21.5% weighting in high yield, slightly above the neutral positioning of 20%.

Selection

We participated in two new issues during June. Firstly, we bought for the Fund an 8-year Euro bond issued by Vonovia. This was part of its acquisition finance for its purchase of Deutsche Wohnen, a fellow German real estate company. The deal gives the company better scale and Vonovia’s corporate bonds had underperformed in anticipation of the supply, so the new issue represented a good entry point.

The second purchase was a high yield bond issued by Vodafone. Even though Vodafone itself is investment grade rated, the bond is subordinated and so slips into the high yield rating category. Corporate hybrids are higher risk instruments, but we believe the coupon of 5.125% in US Dollars is enough to compensate for the extra risk and invested accordingly. I must emphasise that the Fund’s exposure to such subordinated debt remains very low, it is only when the valuation is particularly attractive that we will commit investors’ capital.

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

	Jun-21	Jun-20	Jun-19
Liontrust Strategic Bond B Acc	5.1%	2.8%	5.5%
IA Sterling Strategic Bond	6.1%	3.8%	5.3%
Quartile	3	3	2

*Source: Financial Express, as at 30.06.2021, accumulation B share class, total return (net of fees and income reinvested.

**Source: Financial Express, as at 30.06.2021, 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.

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Key Risks

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

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 which may have the effect of increasing volatility. Some of the Funds may invest in derivatives. The use of derivatives may create leverage or gearing. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead.

Disclaimer

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This 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. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and if you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.