The Fund (C5 sterling accumulation class) returned -0.9%* in sterling terms in Q3 2022 while the ICE Bank of America Merrill Lynch Global High Yield Index (GBP hedged) comparator benchmark returned -1.5% and the average return for the IA Sterling High Yield reference sector was -1.4%. The primary B5 US dollar share class returned -0.7%, while the ICE Bank of America Merrill Lynch Global High Yield Index (USD hedged) comparator benchmark returned -1.0% and the average return for the EAA Fund USD High Yield Bond (Morningstar) reference sector was -2.3%.
We also compare the Fund’s performance to a leading Global High Yield ETF (seeking to outperform by 1.5% a year)†. The Fund’s C sterling shares class return was ahead of that of the ETF in Q3 but has slightly underperformed it since inception (June 2018).
The global high yield Q3 market return of -1.0% (US dollar terms) masks two six-week periods marked by ‘risk on’ then ‘risk off’. At the start of the quarter, indeed from 1st July, markets began to rally based mainly on the idea of a ‘dovish pivot’ from the US Federal Reserve. The tumultuous high yield markets in the first half of the year had mainly been about the impact of rising interest rates/monetary tightening on market liquidity. Rates markets had then begun to reflect a view of the world where inflation was under control, growth was slowing and central banks would be cutting by the end of next year. Risk markets liked the idea of future looser monetary policy.
Yet stubborn inflation data ruined the party, and, from the middle of August, high yield sold off as the ten-year US treasury gradually moved to 4% and higher. By mid-August, the global high yield market had produced a quarter-to-date return of 6.8% in US dollars, only for that to be lost (and some more) by the end of the quarter. A game of two halves. Equity markets had followed a similar path – the correlation between all types of assets, or lack of diversification, remains clear.
Those sectors that are perceived to be longer duration, e.g. telecoms and real estate, were the best performing sectors in the first six week period, and amongst the worst in the second. The high yield market, for now, is like a yoyo under the control of the US rates curve. CCCs have again outperformed, albeit marginally, suggesting to me that the high yield market continues to be more concerned about duration than any recession coming down the line.
In our last quarterly update, we wrote at length about the Fund’s holdings in the real estate sector. At the beginning of this period, Heimstaden announced a bond tender and CPI Property bought bonds back in the secondary market. Both of these holdings held up relatively well during the sell-off in the latter half of this period. Castellum has not yet bought back any of its bonds and its bond underperformed in the risk-off period. Between mid-August and the end of the period, the real estate sector cost the Fund around 30bps relative to index. However, over the full quarter the sector made a significant positive contribution to absolute and relative performance.
The insurance sector was a significant detractor. Each holding we have in the sector is a sterling denominated bond (hedged) and the material under-performance versus index occurred in the aftermath of the UK Chancellor’s ‘mini budget’ and the impact this had on UK government bonds. Two of our three holdings in the sector are issued by companies with investment grade ratings in the life insurance sector. A2 rated Rothesay bonds now yield 11.3% and we have conviction in the long-term prospects for this business. In total, the Fund has around 10% in sterling-dominated bonds.
Our preference towards higher quality bonds and less cyclical sectors skews us towards a slightly longer duration in our credit selection than our index and, likely, our peers. At the start of the year, we had interest rate futures offsetting some of this duration, but, with increasingly higher rates, we removed these hedges.
The Fund therefore feels somewhat higher beta to this rates-driven risk on/risk off dynamic. The bonds that were the strongest performers up until mid-August were amongst the weakest performers in the latter part. Chief amongst these was, for example, the likes of the UK’s Virgin Media, a business we deem to have strong credit fundamentals, or Millicom, a quality Latin American telecom with North European ownership and governance. When the market was rallying on this idea of a Fed pivot, the Fund was first in its UK peer group in July. By mid-August, we had all but closed the underperformance versus index in the year-to-date. However, in the latter half of the period, we gave most of this back.
Outlook
We are making lending decisions based on long-term fundamentals and value, not on short-term market sentiment. The Fund has a yield of around 11.5% for sterling investors (8.9% euro) and an average rating of BB-. Our ability to generate returns in line with this yield is entirely down to the underlying credit quality of the holdings and their ability to refinance in the future. The rates-driven volatility that sees Virgin Media as more volatile than many cyclical CCCs in our view is mark-to-market noise.
If the new issue market remains all but closed, then refinancing risk will increase as a risk to the asset class. In 2023, the European currency high yield market has a small €20bn of maturities, so time is on our side (there is ~€50bn of maturing in 2024). Even this year has seen €22bn of issuance to date (versus €150bn in 2021). Our conviction remains in the higher quality part of the high yield market and believe long terms returns will vindicate this.
Discrete 12 month performance to last quarter end (%)**:
Past Performance does not predict future returns
|
|
|
Sep-22 |
Sep-21 |
Sep-20 |
Sep-19 |
|
Liontrust GF High Yield Bond C Acc GBP |
|
-18.0% |
10.0% |
0.4% |
6.6% |
|
ICE BofA Global High Yield Hedge GBP |
|
-16.9% |
9.8% |
1.3% |
5.4% |
|
IA Sterling High Yield |
|
-14.3% |
10.6% |
-0.4% |
4.7% |
*Source: Financial Express, as at 30.09.22, total return (net of fees and interest reinvested).
**Source: Financial Express, C share class, total return, net of fees and interest reinvested. As at 30.09.22. The primary share class for this Fund is in US dollars (B5) but we are showing the C sterling-hedged class to compare against the IA Sterling High Yield sector.
Discrete data is not available for ten full 12-month periods due to the launch date of the portfolio.
†While the managers of the Fund seek to outperform a leading Global High Yield ETF by 1.5% a year net of fees over rolling three years, this is not a formal objective. There can be no guarantees this will be achieved over the stated time period. The formal objective of the Fund can be found in the Prospectus.
Key Features of the Liontrust GF High Yield Bond Fund
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.
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