Liontrust GF Sustainable Future European Corporate Bond Fund Q4 2024 review | Insights

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

The Eurozone was something of an outlier in this quarter, although yields did still rise over the period, outperformance was attributable to further weakness in the growth outlook and fears over what prospective tariffs from the US might do to already struggling manufacturing sectors in Germany and France.
The Fund’s credit positioning had a positive impact on performance, particularly through sector selection.
We remain constructive on the outlook for corporate bonds based on attractive all-in yields, the carry from spread and our aim of providing additional alpha generation from stock selection.

The Fund returned 0.6%* in euro terms over the quarter, compared with the 0.8% return from the Markit iBoxx Euro Corporates Index comparator benchmark.

Market review

In the first half of the year, European yields trended higher but did outperform their US counterparts, which saw 10y bund yields some 40bps higher by June, before a sharp turn lower following a significant weakening of both Euro-area data and the US labour market in Q3. This proved somewhat short-lived however, and the final quarter of the year saw bonds sell-off aggressively, partly as those fears over the US economy were diminished by the data which followed, and the market digested the US Presidential election result.

The Eurozone was something of an outlier in this quarter, although yields did still rise over the period, with 10-year Bunds around 25bps higher at 2.37%. This outperformance was attributable to further weakness in the growth outlook and fears over what prospective tariffs from the US might do to already struggling manufacturing sectors in Germany and France. While Q3 growth did actually hold up reasonably better than initial expectations, signals from PMIs and other surveys have suggested concern over the future path of growth. Meanwhile, political volatility in France and Germany has done little to suggest these two important economies will have governments likely to galvanise the bloc’s prospects. The ECB has shown greater confidence in the path of rates being lower, which is to be expected given the concerns over growth and with core inflation somewhat lower than in the UK and US.

As it has done for much of this year, the Treasury market set the broad tone for its developed market peers, and a number of factors combined in pushing yields higher. Firstly, the fears over labour market cracking were calmed by subsequent firmer data, while the re-election of Donald Trump to the presidency alongside a Republican sweep of Congress reinforced expectations of inflationary policies around trade and spending. The Federal Reserve then validated market moves in December, delivering a ‘hawkish cut’, with outright dissent on the Federal Open Market Committee against cutting, increases to the median ‘dot’ which signals expectations for the path of the funds rate, and a change in language to signal greater caution going forward.

Much of the UK volatility was attributable to the budget delivered in late October, where the mix of policies announced involved greater spending commitments and a substantial increase in employment costs, which has pushed up inflation projections for 2025. More broadly however, UK data has continued to strike a lacklustre tone. GDP growth has disappointed, with Q3 revised to stagnation at 0.0%, and early indicators for Q4 look sluggish also. Pay growth figures released in December were firm however, and summarised the issue for the MPC – activity appears to be stalling while inflationary pressure remains. The decision to hold rates in December was largely expected, however 3 members advocating for a cut was more dovish than markets had expected. Given the lack of press conference or accompanying forecasts, we will have to wait until February for a detailed update on the committee’s thinking. 10-year gilt yields rose just under 60bps over the quarter, to 4.57%.

Duration

The Fund’s duration position contributed negatively to performance over the period. Our long interest rate positioning proved detrimental to performance as 10-year Bund yields climbed 24bps in the quarter, reaching 2.37% by year-end, while 10-year gilt yields sold off by 56bps.

We started the quarter with an overall duration positioning of 0.50 years overweight to the benchmark, expressed as a 0.25 years long in 10-year Bunds and 0.25 years through 10-year gilts. As gilts underperformed their Euro counterparts, we chose to add a further 0.25 years to our UK duration overweight as 10-year gilts sold off through 4.00% and the cross-market spread versus bunds widened out from 1.70% to 2.20%.

We therefore ended the year with an overweight of 0.75 years of duration relative to the benchmark.

Credit Performance

The Fund’s credit positioning had a positive impact on performance, particularly through sector selection. Security selection was slightly negative. In general, credit performed strongly, with European investment grade spreads ending the quarter 14bps lower. High yield also performed strongly with spreads tightening by 42bps, indicating the strength of the credit market despite the turbulent macro environment.

Within our portfolio, the biggest outperformer was real estate which delivered positive returns from both sector and security selection. REITs tightened significantly over the quarter, hence our moderate overweight position to the sector proved beneficial. From a stock selection perspective, the Fund benefitted from our holding in Annington, following its agreed sale of its Married Quarters Estate back to the Ministry of Defence. Annington subsequently announced a buyback for its outstanding bond issues, at an attractive uplift from where it was trading prior to that announcement.

In the financials space, both banks and insurance continued their strong performance, which therefore meant sector selection contributed positively to performance due to our overweight exposure in both. We remain constructive on Tier 2 bonds and hence we maintained our overweight position in subordinate securities.

Stock underperformance came from the utilities and telecommunications sector. Political uncertainty in Germany affected our exposure there, with questions around the regulatory landscape.

Trading Activity

Credit trading activity was busy over the quarter, amid a backdrop of volatile rates markets.

In financials, following strong performance, we sold down our position to HSBC AT1s following strong performance and used it to fund a new senior preferred issue from Coventry Building Society. In non-financials, we switched between two similar maturity Deutsche Telecom securities, for an attractive pick-up. We also did the same within Smurfit Westrock bonds.

Outside of performance-driven trades, we participated in a tender for our position in Annington, after the company made the decision to sell its portfolio of properties to the Ministry of Defence and take back outstanding bonds. The takeout level was attractive and contributed to performance in the Fund.

Issuance activity was higher over 2024, and last quarter we participated in a number of new issues. We added the inaugural bond from Kingspan. Kingspan is a company that offers a range of insulation, roofing and cladding solutions with exceptionally sustainable products which we believe will help decarbonise our economies by reducing the energy required to keep our buildings at the correct temperatures. We also participated in a new issue from Equinix. Equinix operates data centres and offers interconnection services globally. Data centres provide the backbone to how we store and process data and underpin the functioning of the digital economy, which can drive improvements in making the real economy cleaner, healthier and safer. Equinix is at the forefront of innovating and driving technologies that increase the efficiency of data centres and has a long-term goal of using 100% clean and renewable energy. We funded the new issue by selling out of our position in RELX, which had performed well.

We disposed of our position to Snam Gas following fears of declining volumes and increasing electrification leading to stranded asset risk. Valuations between gas and electricity networks have narrowed, so we reinvested the proceeds into a new holding of E.ON. E.ON primarily operates electricity distribution networks and is mostly exposed to regulated revenues.

Outlook

We remain constructive on the outlook for corporate bonds based on attractive all-in yields, the carry from spread and our aim of providing additional alpha generation from stock selection. We are cognisant however that spreads have performed strongly and are now looking more expensive than they did previously, although there is scope for further tightening.

There has been a normalisation in overall credit fundamentals, such as interest cover metrics, as increasing all-in cost of new financing has resulted in an upward trend in blended funding costs and a corresponding reduction in interest cover. Leverage has returned to long run averages, as increasing debt levels have exceeded lower EBITDA growth, the latter having resulted from a combination of lower revenue growth and rising costs. However, both of these metrics remain at healthy levels.

We therefore look for additional performance to be generated from credit selection, an area where we have delivered outperformance over recent years. We are exposed to high quality names that on a relative basis offer attractive value and good exposure to the asset class. This is reflected in our overweight positioning to financials through both the banks and insurance sectors, and our overweight in telcos which we view as a high-quality resilient sector. We expect there to be potential for additional capital upside from declining government bond yields and the funds retain their long interest rate position.

When credit spreads are combined with still elevated gilt yields, all in yields still present an attractive opportunity. Currently, our Fund’s gross redemption yield is 3.52%, stemming from high quality investment grade credit.

For 2025, we expect a modest growth environment, and even though markets have been recently challenged with persistent inflation and fears of higher rates for longer, we believe that ‘risk-free’ rates will decline over 2025. The Eurozone growth backdrop looks vulnerable with both France and Germany struggling, while the political uncertainty in both countries could generate further volatility. Meanwhile, we believe the UK will start showing signs of weakening economy sooner than the market expects, which should see yields there outperform versus peers. The ECB seem more comfortable cutting rates than many other central banks, which should provide support for risk markets should the situation deteriorate, though we take comfort in what we say as stable fundamentals for European corporates and a resilient outlook.

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

	Dec-24	Dec-23	Dec-22	Dec-21	Dec-20
Liontrust GF Sustainable Future European Corporate Bond A5 Acc EUR	5.0%	10.4%	-14.8%	-0.3%	1.0%
Markit iBoxx Euro Corporates Index	4.6%	8.2%	-14.2%	-1.1%	2.7%

*Source: FE Analytics, as at 31.12.24, 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.

The Fund aims to maximise total returns (a combination of income and capital growth) over the long term (five years or more) through investment in sustainable securities, primarily consisting of European investment grade fixed income securities. The Fund invests at least 80% of its assets in bonds issued by companies which are denominated in Euro or non-Euro corporate bonds that are hedged back into Euros. The focus is on investment grade corporate bonds (i.e. those which meet a specified level of creditworthiness). The Fund invests in companies that provide or produce more sustainable products and services as well as having a more progressive approach to the management of environmental, social and governance (ESG) issues. Although the focus is on investment grade corporate bonds, the Fund may also invest in government bonds, high yield bonds, cash or assets that can be turned into cash quickly. Where the Fund invests in non-Euro assets, the currency exposure of these investments will generally be hedged back to Euro. Up to 10% of the Fund's currency exposure may not be hedged, i.e. the Fund may be exposed to the risks of investing in another currency for up to 10% of its assets. The Fund may invest both directly, and through the use of derivatives. The use of derivatives may generate market leverage (i.e. where the Fund takes market exposure in excess of the value of its assets). The Fund has both Hedged and Unhedged share classes available. The Hedged share classes use forward foreign exchange contracts to protect returns in the base currency of the Fund.

5 years or more.

3 (Please refer to the Fund KIID for further detail on how this is calculated)

Active

The Fund is considered to be actively managed in reference to IBOXX Euro Corporate All Maturities (the "Benchmark") by virtue of the fact that it uses the benchmark(s) for performance comparison purposes. The benchmark(s) are not used to define the portfolio composition of the Fund and the Fund may be wholly invested in securities which are not constituents of the benchmark.

The Fund is a financial product subject to Article 9 of the Sustainable Finance Disclosure Regulation (SFDR). You can learn more about our implementation of the SFDR here.

Understand common financial words and terms See our glossary

KEY RISKS

Past performance does not predict future returns. You may get back less than you originally invested.

We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments

All investments will be expected to conform to our social and environmental criteria.
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 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.

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DISCLAIMER

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It 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.

This information and analysis 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, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.

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