Liontrust GF Absolute Return Bond Fund

The Liontrust GF Absolute Return Bond Fund (C5 share class) returned 2.4%* in sterling terms in Q3 2024 and the IA Targeted Absolute Return, the Fund’s reference sector, returned 1.6%. The Fund’s primary US dollar share class (B5) returned 2.6%.

The capital gain driven by the rally in underlying sovereign bond markets produced the largest positive impact for the Fund during the quarter. The manifestation of this gain in the Fund emanates from both the inherent duration from investing in short-dated credit and our strategic long duration position within the Fund’s low duration parameters. The yield carry on the Fund was the second biggest contributor to the total return during the third quarter. Stock selection provided a small positive contribution to performance too.

Market backdrop

The third quarter has seen a shift in the narrative emanating from most developed market central bankers. 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 changing narrative, along with some select weakening economic data, helped produce a strong quarter for bond market returns.

The quarter built up toward the first interest rate cut of this cycle from the US Federal Reserve in September. Prior to the Federal Open Market Committee (FOMC) meeting there was a lot of debate about whether rates would be cut by 25bps or 50bps. In the end, the Fed opted for a 50bps reduction to take the range to 4.75% to 5.0% in a move marketed as a recalibration of policy. The vote split was 11-1 with Bowman favouring a 25bps cut in the first dissenting vote since 2005.

The FOMC meeting was accompanied by the quarterly update of the Fed’s Summary of Economic Projections (SEP). In my opinion a compromise was reached with a starting 50bps rate cut but then the dot plot forecasting a pace of cuts of 25bps at each of the two remaining meetings this year. The Fed’s shifting focus from the inflation to the full employment part of its mandate is clear to see as it states “…the risks to achieving its employment and inflation goals are roughly in balance.”  This led naturally to the rationale for the cut being “…in light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point.” With economic activity still characterised as being “solid,” Chair Powell’s emphasis is that this rate cut is about “recalibration” of monetary policy.

The dot plot of FOMC members’ current projections for rates shows the disparity of views on the Committee.  The median case for two more 25bps cuts, to take Fed funds rates to finish 2024 in the 4.25% to 4.50% range, only has a slim majority on the FOMC. There are 100bps of further cuts projected for 2025, with an additional 50bps completing the easing journey in 2026; the further one looks into the future the greater the disparity there is between FOMC members’ views. One development that will become more important in 2025 is the debate about where longer-term neutral rates are; the latest SEP added 0.1% to terminal rates, taking them from 2.8% to 2.9%.

Fed Chair Powell did a great job at the press conference phrasing the 50bps as a recalibration, so the Fed is neither overly concerned about current conditions nor embarking on a series of rapid rate cuts. One quote that many have latched on to is “…I do not think that anyone should look at this and say, ‘Oh, this is the new pace, ” with Powell then saying “…the economy can develop in a way that would cause us to go faster or slower.” I continue to expect the US labour market to exhibit further softening, driven by both the increased supply of labour and lessening demand, particularly amongst SMEs who are feeling the crunch more in this cycle. With the US consumer remaining robust, I do not anticipate a collapse in employment. My view remains that US unemployment will peak somewhere in the 5% - 6% range in this cycle. If I am correct that the labour market will gradually keep easing, then the Fed will undertake further 50bps cuts – whether this is in 2024 or 2025 remains to be seen. Fears over a non-linear labour market (when things start to go wrong, they do so rapidly) are likely to motivate the Fed to approach neutral rates sooner rather than later.

While the Fed was the main event, other central banks are definitely worthy of a mention. Having already started its rate cutting cycle, the European Central Bank (ECB) held interest rates steady in July before cutting again by 25bps to 3.50% in September. The rationale for this cut was “…based on the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it is now appropriate to take another step in moderating the degree of monetary policy restriction.”  The guidance remains very non-committal: the ECB “…will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.”

The staff forecasts saw their quarterly update; the headline inflation projections are unchanged, core inflation projections for 2024 and 2025 were revised up by 0.1% “…as services inflation has been higher than expected.” The ECB argues that domestic inflation is high due to continued rises in wages; however, it goes on to note that “…labour cost pressures are moderating, and profits are partially buffering the impact of higher wages on inflation.” There was a downgrade to growth forecasts mainly due to weaker domestic demand. I’d argue that these updated forecasts give a good balance between hawkish and dovishness; the ECB has marked-to-market sticky services inflation in its forecast for core CPI, however easing wage pressures and weak domestic consumption suggest downside risk in the longer term.

Finally, 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 it says “…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. At its next meeting in September the MPC kept rates on hold. There was one important sentence added to the guidance paragraph of the MPC’s statement: “…In the absence of material developments, a gradual approach to removing policy restraint remains appropriate.” This strongly hints that the MPC is not in a rush to do back-to-back interest rate cuts, nor does it want to deviate from 25bps increments. The next MPC meeting is in November, when it will be accompanied by an updated quarterly monetary policy report. An interest rate cut at the MPC’s November meeting would be very likely anyway even if the UK did not have an Autumn Budget on 30 October which will see taxes being raised. 

For all of these central banks, the exact timing of cuts does not matter to us as bond managers that much; what does matter is that the economic conditions are in place for the cuts. We remain strategically long duration and we believe it is still a good time to be locking in attractive bond yields.   

Fund performance

We split the Fund into the Carry Component and three Alpha Sources for clarity in reporting, but it is worth emphasising we manage the Fund’s positioning and risk in its entirety. As a reminder, the Carry Component invests in investment grade bonds with <5 years to maturity. Within this there is a strong preference for investing in the more defensive sectors of the economy. 

The capital gain driven by the rally in underlying sovereign bond markets produced the largest positive impact for the Fund during the quarter. The manifestation of this gain in the Fund emanates from both the inherent duration from investing in short-dated credit and our strategic long duration position within the Fund’s low duration parameters. The yield carry on the Fund was the second biggest contributor to the total return during the third quarter. Stock selection provided a small positive contribution to performance too.

Alpha sources

Rates

The Fund’s permitted duration range is 0 - 3 years with a neutral level of 1.5 years. The Fund started July with a duration of 2.0 years. After the strong sovereign bond rally during the month, we reduced this by 0.1 years and the rest of the quarter saw duration oscillate closely around 1.90 years. The duration split at the end of September was 0.6 years in the US, minus 0.5 years in Canada, 0.6 years in New Zealand, 0.7 years in Europe, and 0.5 years in the UK. 

Cross market rates selection was a small positive during the quarter. The Fund remains short Canadian duration relative to the US; the US slightly outperformed Canada, the latter remains further through the economic cycle but the valuation discrepancy more than compensates for this. The Fund is long Kiwi duration relative to the US; New Zealand’s sovereign bonds gained against the US for most of the quarter but retrenched towards the end of the period leaving the contribution flat. Finally, with the UK gilt market continuing to lag other developed economy rates markets we added to UK duration out of the US – this is offside so far since the position was established.

Allocation

The weighting in the Carry Component has been in the mid to high 80s percentage area throughout the quarter, due to the compelling yield on short dated defensive investment grade. As credit spreads are expensive, we have further reduced exposure to other credit in Selection, which is now only 2%. The high yield weighting in the Fund is mandated to always be low and is currently zero.

Selection

Stock selection was a small positive contributor to performance during the quarter. Each contribution was incremental in nature with Rothesay Life and Castellum bonds being the best two; profits were taken on both of these Selection positions. Staying within Selection, bonds in AIA Group were also sold; they have done well this year but had minimal impact during the quarter.

Within the Carry Component there were various bond maturities during the quarter including eBay, Goldman Sachs, and Bristol Myers Squibb. A sale was made of Warner Bros Discovery due to the risk of corporate activity which could lead to a detrimental credit rating outcome for the bonds. Purchases included food and ingredients company Kerry, medical equipment maker Stryker, forest lodge holiday specialist Center Parcs, and credit provider Capital One. The latter purchase replaces bond exposure that matured earlier in 2024.  Finally, we switched some of real estate company Aroundtown’s euro denominated bonds into those issued in US dollars for a significant increase in credit spread.

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

*Source: Financial Express, as at 30.06.24, total return (net of fees and interest reinvested), C5 class. Discrete data is not available for ten full 12-month periods due to the launch date of the portfolio.

Key Features of the Liontrust GF Absolute Return 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.

The fund manager considers environmental, social and governance (""ESG"") characteristics of issuers when selecting investments for the Fund. Overseas investments may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund.  Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay. The Fund can invest in derivatives. Derivatives are used to protect against currency, credit or interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The Fund uses derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash. The Fund invests in emerging markets which carries a higher risk than investment in more developed countries. This may result in higher volatility and larger drops in the value of the fund over the short term. The Fund may encounter liquidity constraints from time to time. Participation rates on advertised volumes could fall reflecting the less liquid nature of the current market conditions. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails. There is no guarantee that an absolute return will be generated over a rolling 12 month period or any other time period.

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.