Liontrust Strategic Bond Fund

The Liontrust Strategic Bond Fund returned 1.2%* in sterling terms during September. The average return from the IA Sterling Strategic Bond sector, the Fund’s comparator benchmark, was 0.7%.

Market backdrop

The main event in the bond markets in September was the US Federal Reserve interest rate cut. In the build up to the Federal Open Market Committee (FOMC) meeting there was a lot of debate about whether rates would be cut by 25 basis points (bps) or 50bps. In the end the Fed opted for a 50bps reduction to take the range to 4.75% to 5.0%; the move was 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%.

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. The European Central Bank (ECB) cut rates by 25bps to 3.50% as was expected by all surveyed economists and market pricing. 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 while 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, the Bank of England’s Monetary Policy Committee (MPC) held interest rates steady at 5.0% as was widely anticipated. The vote split was 8-1 with Ramsden going with the majority, leaving Dhingra as the sole dove voting for a cut. 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 do they 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.  

Fund positioning and activity

Rates

The Fund’s duration was maintained at 6.5 years during September. Underneath the headline figure there was a cross-market adjustment: US Treasuries have outperformed their European sovereign cousins and when the yield spread between the 10-year Treasury and 10-year German Bund got as low as 150bps we switched 0.5 years of duration from the US into Bunds. The geographic split of duration is now 1.7 years in the US, -0.7 years in Canada, 1.1 years in New Zealand, 2.4 years in the Eurozone, and 2.0 years in the UK.  

As a reminder, we continue to think that yield curves will steepen further, the Fund’s net duration exposure in the 15+ year maturity bucket is zero; we prefer short-dated and medium-dated bonds.  

Rates

Credit spreads remain expensive by historic standards. The Fund is underweight with 42% in investment grade (48% in bonds minus a 6% overlay) and 14% in high yield (19% in bonds minus a 5% overlay), compared to neutral levels of 50% and 20% respectively. Credit fundamentals remain robust and we are just awaiting a better valuation opportunity to increase exposure.

Dispersion between individual corporate bond valuations still allows us to add value at the stock level. Purchases during September included debt issued by the Irish food and ingredients company Kerry, logistics focused property company Segro, and a subordinated bond from the Italian gas network company Snam. On the sales side of the ledger, the Fund’s position in VW was sold as swathes of the automotive industry are struggling with competitive pressures, and profits were taken in beauty company Coty which has been a great credit improvement story which is now reflected in bond valuations.

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

*Source: Financial Express, as at 30.09.24, accumulation B share class, total return (net of fees and income reinvested).**Source: Financial Express, as at 30.09.24, accumulation B share class, total return (net of fees and income reinvested).

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. 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. 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. 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.

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.