Liontrust GF Strategic Bond Fund

The Liontrust GF Strategic Bond Fund returned 2.5*in US dollar terms in July. The average return from the EAA Fund Global Flexible Bond (Morningstar) sector, the Fund’s reference sector, was 1.6%.

Market backdrop

There has been a shift in the narrative emanating from most developed market central bankers over the last few months. For the last couple of years the focus has been on taming inflation and, for some, rebuilding credibility after incorrectly referring to inflation as “transitory.” The recent shift has been toward looking at more balanced risks: with restrictive monetary policy creating a drag on economic activity, central bankers do not want to cause unnecessary economic pain by keeping rates too high for too long. This shift, along with weakening economic data, especially US inflationary data during July, helped produce a strong month for bond market returns.

Starting with the Federal Reserve, during July the Federal Open Market Committee (FOMC) held the Fed funds rate steady in the 5.25-5.50% range as was expected by economists and market pricing. There were some dovish developments in the statement that hint towards, but do not promise, the first US rate cut of this cycle in September. Firstly, the FOMC statement says that “…in recent months, there has been some further progress toward the Committee's 2 percent inflation objective,”; in the prior statement the environment was described as “modest further progress.” Secondly, the Fed joined in pointing towards more balanced risks; it states “…the Committee is attentive to the risks to both sides of its dual mandate.” Previously the emphasis was on being “…highly attentive to inflation risks.” In my opinion, it would take a dramatic shift in economic data to prevent the imminent US rate cut occurring; also, an equally dramatic but opposite shift in the data to persuade the Fed to cut by 50 basis points (bps) in September.

Having already started its rate cutting cycle, the European Central Bank held interest rates steady at 3.75% in July. One dovish tilt was the lack of concern about May’s inflation data: “…while some measures of underlying inflation ticked up in May owing to one-off factors, most measures were either stable or edged down in June.”  Offsetting that at a hawkish angle was the lack of any guidance or signals about a cut in September. The ECB remains data dependent and, during the press conference, Lagarde stressed that it is broad data rather than any one point in particular. A rate cut at the September meeting is highly likely to occur but not guaranteed.

On August 1^st the Bank of England’s Monetary Policy Committee (MPC) initiated its first interest rate cut of this cycle, reducing rates by 25bps to 5.0%. In the MPC statement they say “…it is now appropriate to reduce slightly the degree of policy restrictiveness” i.e., monetary policy is still very tight but just slightly less than it was before the cut. The vote split makes a consecutive cut in September highly unlikely. The five who voted for the cut were Bailey, Breeden, Dhingra, Lombardelli and Ramsden; the MPC statement says that for some of these five the “…decision was finely balanced. Inflationary persistence had not yet conclusively dissipated, and there remained some upside risks to the outlook.” My assumption is that the prior doves (Ramsden, Dhingra) needed no persuading but that the centrists (Bailey, Breeden, Lombardelli) are the ones who just managed to tip the balance. The most illuminating comment was in the opening remarks to Governor Bailey’s press conference: "…we need to put the period of high inflation firmly behind us and we need to be careful not to cut rates too much or too quickly." The four hawks (Greene, Haskel, Mann, Pill) still want to see stronger evidence that upside pressures for inflation have abated. This was Haskel’s last meeting; no replacement has yet been announced so September’s meeting probably sees an MPC of eight voters. The next meeting after that is in November – this conveniently comes after the tax rises that will be announced in the UK’s October 30 budget and is accompanied by the next monetary policy report.

Finally, there is one central bank heading in the other direction: the Bank of Japan raised interest rates to 0.25% from the prior range of 0.0% to 0.1%. This was a surprise relative to economists’ expectations but not a shock as markets were pricing in a reasonable chance of a hike occurring. The monthly amount of Japanese Government Bonds (JGB) the Bank of Japan buys will be gradually tapered down by 400 billion yen a quarter from the current 5.7 trillion yen pace to 2.9 trillion in the first three months of 2026. With the stock of JGBs on the Bank of Japan balance sheet experiencing numerous maturities during this period, the total size of the Bank of Japan’s JGB holdings is expected to shrink by 7-8% by the end of Q1 2026. The guidance is data dependent; if the Japanese economy progresses in line with Bank of Japan expectations then further hikes will happen – in their words: “…if the outlook presented in the July Outlook Report will be realized, the Bank will accordingly continue to raise the policy interest rate and adjust the degree of monetary accommodation.” I do not yet believe the Japanese economy is in a structurally self-fulfilling inflationary environment and the Bank of Japan is fighting the post-Covid forces as opposed to entering a new paradigm. There is no Japanese duration exposure in the Fund; this is unlikely to change for the next few quarters, but if the Bank of Japan overtightens (mistaking the cyclical for the structural) then this would create a buying opportunity.

For the majority of developed market central banks, the rate cutting cycle is underway or about to start. The economic conditions are not yet in place for rapid cuts, but it would only take a deterioration in labour markets to shift the focus more substantially from inflation to employment and accelerate the monetary easing cycle.

Fund positioning and activity

Rates

We continue with our rates strategy of being long duration exposure and positioned for yield curve steepening.  On the latter, the Fund’s net duration exposure in the 15+ year maturity bucket is zero; we continue to prefer short-dated and medium-dated bonds.

Overall Fund duration was reduced by 0.5 years during July. This is both tactical, giving room to buy if yields backup again as we approach the US election, and a reflection of the risk/return equation. At 6.9 years’ duration exposure the Fund remains significantly long against both index and peers. The geographic split is 2.6 years in the US, -0.5 years in Canada, 0.9 years in New Zealand, 2.0 years in the Eurozone, and 1.9 years in the UK. 

Allocation and Selection

Asset allocation was effectively unchanged during July. High yield exposure is 13% compared to neutral of 20%; there is 20% exposure to bonds minus 7% in the CDS overlay. Investment grade exposure remains below neutral too at 40% compared to a 50% neutral. This underweight position in credit gives the Fund a lot of risk budget to buy once credit spreads widen. We are targeting adding exposure to corporate bonds during a period of volatility as opposed to anticipating a significant uplift in defaults and the permanent destruction of capital.

Discrete years' performance (%) to previous quarter-end**:

**Source Financial Express, as at 31.07.24, total return, B5 share class. Discrete data is not available for ten full 12-month periods due to the launch date of the portfolio (13.04.18).*Source: Financial Express, as at 30.06.24, B5 share class.