Liontrust GF SF European Corporate Bond Fund

The Liontrust GF SF European Corporate Bond Fund returned 1.3%*^† in euro terms over the quarter, compared with the 1.2% return from the Markit iBoxx Euro Corporates Index comparator benchmark.

Market backdrop

Despite improved performance over the final quarter of the year, 2022 proved to be one of the worst years for asset returns in the last 20 years. Central banks struggled to control persistently high inflation, with significant interest rate increases dominating markets in 2022.

In the final quarter, investor optimism focused on the belief that peak inflation had been achieved, following weaker inflation data. This led to a reduction in expectations for where interest rates would finally peak. This saw all of the US federal Reserve, Bank of England and European Central Bank deliver reduced rate increases of 50bps in December. However, the accompanying hawkish commentary from the US Federal Reserve and European Central Bank resulted in yields moving higher towards the end of the quarter.

Inflationary pressures have started to alleviate in Europe, with euro area inflation falling from a peak of 10.6% to 10.1% in November. This was despite heavy reliance on Russian gas, as a milder than expected winter saw falling gas prices help to alleviate inflation pressures.

This was positive for risk assets, as investors grew more hopeful that we are approaching the end of monetary tightening. The ECB now expects average inflation of 8.4% in 2022, 6.3% in 2023, 3.4% in 2024 and 2.3% in 2025. It sees recession in the region being relatively short lived and shallow.

Similarly, Q4 finally showed some encouraging signs that inflation might have peaked in the US which saw relief rallies in bonds, as Federal Reserve Chair Jerome Powell hinted that future interest rate hikes would be dialled down. Headline inflation fell to just over 7%, having peaked above 9% in June, following consecutive downside surprises, leading markets to start pricing in interest rate cuts as soon as late 2023.

Whilst there has been some softening in the economic data the labour market continues to be resilient with unemployment remaining at 3.6%. This Fed remains focussed on this and is watching for signs that the labour market is easing.

In the UK, the political landscape stabilised following the inevitable regime change amidst the turmoil following September’s disastrous mini-budget announcement.

In October, Rishi Sunak was appointed as the new Prime Minister, with Jeremy Hunt the new Chancellor, who swiftly reversed almost all of the fiscal stimulus measures announced in the mini budget, while also promising further fiscal tightening to come. This reassured market concerns about the scale of unfunded government spending plans, with equities and bonds staging large rallies in mid and late October, recovering much of the previous month’s underperformance, as 10-year gilt yields fell sharply from a decade high of 4.5%. The pound also recovered against the US dollar.

This positive sentiment was somewhat tempered by the latest inflation print, which, despite falling from 11.1% in October to 10.7% in November, remains more persistent than in the US and Europe. This saw the Bank of England maintain a more hawkish approach despite the drop in headline inflation.

The Bank of England now expects UK GDP to decline by 0.1% in 2022 Q4, 0.2% better than expected in the November Report. Inflation, however, is expected to fall sharply from mid-2023 to below the 2% target in years two and three of the projection.

On a similar trend, labour demand has begun to ease, with the unemployment rate rising slightly to 3.7%, but it still remains tight.  Despite a somewhat resilient labour market, we have seen a clear deterioration in the real economy, with household consumption weak and most housing market indicators continuing to soften.

Fund review
The Fund’s relative outperformance was primarily driven by our overweight credit position, as corporate bonds rallied strongly amidst a risk-on tone as investors grew increasingly optimistic that we are approaching the end of the monetary policy tightening cycle. This was driven by a combination of strong sector allocation and stock selection across our core sectors.

Financials were the biggest outperformers as our allocation to the Banks and Insurance sectors benefitted from a strong recovery on improved macro-economic sentiment, particularly given our overweight allocation to higher beta subordinated bonds.

Meanwhile, our overweight to the Telecommunications sector also delivered strong positive contribution over the period, particularly stock selection as our higher beta and longer spread duration holdings outperformed.

This outweighed the drag on performance from our exposure to the Real Estate sector as the combination of high inflation, tightening financial conditions, rising yields and the growing threat of recession have weighed on the property market, particularly amongst higher beta names, such as Aroundtown and Canary Wharf. There was also negative contribution from our more defensive allocation to Bunds.

Rates attribution was broadly neutral after we lengthened the Fund’s duration position to neutral versus its benchmark.

Rates positioning was proactive as we continued to actively manage the Fund’s duration over the quarter.

Following central bank willingness to hike by more, we closed our underweight duration position to Europe. We are now neutral duration, supported by the high all-in levels of yields, better than expected levels of gas storage over the winter, and recent comments by some European central bank members to stop hiking after the next meeting.

Fund trading activity was muted over the period. While issuance picked up, demand was high and certain deals that appeared attractive came at expensive valuations. Even challenged names had order books multiple times oversubscribed.

Outlook

As we enter 2023, the market is approaching a potentially important transition period that could see the 2022 headwinds ease in the months ahead.

Inflation has shown definitive signs of peaking, and while still too high in an absolute sense, it could prove a positive surprise if price pressures ease faster than expected.

On a monetary policy level, the hiking campaign is likely near complete. In December, the Fed signalled that it expected the peak interest to rate be  75bps higher than current rate, which could easily be reached in the first few months of 2023.

Economic growth and corporate earnings are indeed expected to decline in 2023, but these expectations now seem to have been fully priced into equities and bonds at current levels. We believe the focus of the market should turn to single name issuers and fundamentals and move away from monetary policy tracking.

From an investment perspective, corporate spreads also appear to be making steady progress in tightening, after spiking to 2020 levels this summer. This should help corporates improve their financing conditions on new debt issuance in 2023.

Declines of the magnitude we saw in 2022 are usually followed by strong recoveries. Bonds, as represented by the Bloomberg US Aggregate bond Index, have never experienced two consecutive years of negative returns. Therefore, we think market declines seen in 2022 have ultimately yielded substantial long term opportunities in the fixed income markets. Slower growth should be constructive for fixed income securities, which, coupled with current attractive valuations and well positioned corporate balance sheets, presents an  opportunity for the sector and offers investors attractive compensation.

Discrete years' performance*, to previous quarter-end:

Past performance does not predict future returns

*Source: FE Analytics, as at 31.12.22, A5 share class, in euros, total return (net of fees and income reinvested). Discrete data is not available for 10 full 12-month periods due to the launch date of the portfolio.

Key Features of the Liontrust GF SF European Corporate 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 the 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.  The Distribution Yield is also the Underlying Yield for this fund. 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

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.