Liontrust Strategic Bond Fund

The Liontrust Strategic Bond Fund returned -0.5%* in sterling terms in November. The average return from the IA Sterling Strategic Bond sector, the Fund’s comparator benchmark, was 0.2%.

Market backdrop

The announcement of a new Covid-19 variant, Omicron, superseded all other news in November. We are currently in an evidence vacuum, with financial markets strongly reacting to anecdotes instead. Government policy responses will depend on the transmissibility of the Omicron variant, how severely it affects people and whether it can evade vaccines. In my opinion, the most important figure will not be the headline first efficacy number about preventing infection, it will be the second efficacy number regarding whether vaccines predominately prevent severe symptoms. Provided that the effectiveness of vaccines against hospitalisation from the variant remains high then western health systems will not be strained much further than they currently are (except for those countries with lower vaccination rates that are already suffering from a surge in Delta variant infections). The implicit government policy approach in many western countries does appear to be to only increase restrictions on economic activity when the health service is approaching capacity limits. Putting economics to one side for a moment, the latest variant once again shows the importance of making sure the whole world has access to vaccines.

While we have huge respect for scientists and medical professionals guiding as through the crisis, regular followers of our commentary will know that we have a lot less respect for central bankers. Rates were kept artificially low for the last decade and monetary policy no longer needs to be on an economic emergency footing with rampant inflation at 6.2% in the US and 4.9% in the eurozone. Jerome Powell was elected for a second term as Chair of the Federal Reserve during November, and I do see some hope that he intends to be slightly more hawkish. He has decided to retire the use of the word transitory to describe inflation and is openly talking about speeding up the pace of tapering (of quantitative easing). Whilst retiring the word transitory is a tacit admission of having got economic projections wrong – inflation has been higher and stickier than the Fed forecast – at least it is an important first step on the road to the realisation that interest rates should be much higher.

With a flurry of anticipated news regarding the Omicron variant, and the FOMC meeting on 14-15th, it is clear that December will not represent a quiet end to 2021. I cover below how we have adjusted Fund positioning throughout November.

Rates

The Fund’s duration was reduced early in November, from a temporary high at month end of 3.25 years, back down to 3 years; this was through selling the Australian bond future. This action leaves the Fund with a pure relative value trade in Antipodean markets: long New Zealand government bonds and short the Australian future.

For the rest of the month, prior to the Omicron variant news, activity within rates was very much tactical in nature. The Fund successfully bought and sold the German 30-year Buxl future, exploiting its volatility. Our core strategic position remains low beta, with approximately two years in the dollar bloc countries and one year in Europe including Switzerland. The preference for intermediate maturities of the curve, the 5 to 15-year tenors, remains in place. We hope to see the US 5s30s curve flatten to 50bps in order to instigate a strategic steepening position.

We believe the sovereign bond markets over-reacted to the news on the Omicron variant. With Canadian 10-year yields falling 25 basis points, we took the opportunity to shorten the Fund duration to 2.75 years. As more evidence on the variant arises, we may seek to shorten duration further.

Allocation

In the context of 2021, there was meaningful widening in credit spreads during November; on longer-term charts one would not notice so much! Investment grade credit spreads widened by 22bps in the eurozone, from 87bps to 109bps. The US market was calmer but still widened by 13bps. We retain an underweight position, having 40% exposure (45% physical minus a 5% overlay) compared to neutrality at 50%. We did alter the spread duration of the holdings.

We also used the volatility at month end to increase the Fund’s high yield exposure to 27.5% (23.5% in physical holdings and a 4% overlay), but there remains a huge quality bias within this. There is lots of scope to add further risk, but we would need better valuations to galvanise us into doing so.

Selection

November saw the return of an old favourite into the Fund’s holdings list. From their mid-summer tights, the credit spread relative to Bunds on Eli Lilly €1.7% 01/11/2049 bonds had widened 35 basis points. We took this opportunity to buy back in; a retracement of half of the widening would generate 5% of capital upside and make the Fund a good handful of basis points (the duration contribution is hedged out using Buxl futures). On the flip side, we sold some shorter dated bonds in Marsh & McLennan as they had been relatively strong performers. 

Let’s hope for more volatility in 2022 – for the ‘right’ reasons of central banks tightening as opposed to pandemic developments – so we see more opportunities for switches like this.

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

*Source: Financial Express, as at 30.11.2021, accumulation B share class, total return (net of fees and income reinvested.

**Source: Financial Express, as at 30.90.2021, 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. 

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.

Investment in the Strategic Bond Fund 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 Fund 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

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.