Liontrust Sustainable Future Monthly Income Bond Fund

• Complex geopolitical dynamics and unforeseen international developments contribute to risk-off sentiment and falling US government bond yields.

• Cross-market position in UK gilts (long) versus German Bunds (short) contributed positively to performance. Overweight UK duration maintained despite quarterly yield increase as we expect greater economic weakness than is priced in.

• Within credit, sector and security selection were positive. With spreads having tightened and corporate fundamentals moderated somewhat, we think future performance will come predominantly from selection.

The Fund returned 1.0% over the quarter, compared to 1.0% return from the IA Sterling Corporate Bond sector (comparator benchmark) and 0.5% return from the iBoxx Sterling Corporates 5-15 Years Index (target benchmark)*.

Market review

This year has already witnessed a dramatic surge in global policy shifts, driven by complex geopolitical dynamics and unforeseen international developments. The new administration in the US kicked off their policy agenda which has led to a rapid reassessment of global security alliances and fears over the global growth backdrop. Ambiguity surrounding policy has affected both business and consumer confidence, heightening concerns over higher-risk asset classes.

The quarter began with a coordinated sell-off in global fixed income markets, a move which started in November after President Trump's election, and partly attributable to firm economic data in the United States, along with expectations of increased inflation resulting from the proposed policy agenda. Volatility rose as the quarter progressed with numerous tariff announcements and proposals. There was a significant outperformance by US treasuries, particularly towards the end of the quarter, as uncertainty over tariffs further drove recessionary fears and a growing risk-off move. The US 10-year yield fell nearly 40 basis points over the period, while concerns over stagflation linger given the tariff uncertainty. The Conference Board’s consumer confidence measure fell to the weakest level since January 2021 in March, while measures of inflation expectations have moved significantly higher amid the tariff backdrop.

Keeping with recent tradition, the UK has followed much of the US moves. Some differentiation arrived via the Spring Statement, however. Chancellor Reeves was able to rebuild fiscal headroom to same level as the October’s statement’s level, which had been wiped out by rising gilt yields and weaker GDP growth. Savings were achieved by cutting welfare spending, backloading savings on other expenditure, and a reallocation to defence spending which flatters the narrow ‘fiscal rules’ interpretation of the public finances. Markets responded positively to a revised gilt remit for FY 2025-26, coming in just under £300 billion, with a shift in issuance away from longer-dated bonds causing the curve to flatten. Despite this, risks to fiscal policy and its impact on GDP growth remain. The OBR projects 1% growth for 2025 but the longer-term assumptions seem optimistic at best. Productivity rebounding from 0.3% to 1.0% seems unlikely, while no potential tariff increases were included in the base case in spite of White House rhetoric. Full tariff implementation could reduce UK GDP by up to 1% according to the OBR, negating the entire projected current budget surplus for 2029-30 in its own estimations. Given this uncertainty, it is worth noting that the likelihood assigned to the government achieving a current budget surplus by the forecast's end sits at only 54%. The outlook points to further fiscal consolidation being needed in the future, the form of which we will need to wait to see.

The Eurozone also moved in response to the US administration’s policy agenda, particularly with regard to confrontational foreign policy. This includes proposals from European Commission President Ursula von der Leyen for €800 billion on defence spending at the European level. More radically, in Germany, proposals to ease the ‘debt brake’ for defence spending and a new €500 billion infrastructure spending plan caught markets by surprise in March. 10-year Bund yields rose by 30 basis points on the day in response, their largest rise since German reunification. The infrastructure spending in particular is likely to have a positive multiplier, increasing growth and jobs but also increasing inflation. Germany has had decades of restrained fiscal policy, and so is in a unique position to be able to implement such measures. The European Central Bank validated the prospect of further stimulus, with the bank’s President Lagarde praising the approach in the last meeting. Otherwise, the bank has progressed as expected. Interest rates were cut twice over the quarter, with a further 60 priced in by the end of the year.

Given the circumstances, investors are looking for insulated assets in which to invest their capital. While tariffs have the potential to temper earnings, many corporates are entering this uncertain period from a solid base, with many having termed out debt while interest rates were low. Corporate bonds have often outperformed in stagflationary environments, which is becoming ever more likely with each geopolitical development.

Fund performance

Duration

The Fund delivered positive performance from a duration management perspective, primarily due to its cross-market 0.25 years long position in 10-year UK gilts along with a short position of 0.25 years in 10-year German Bund futures.

Spending plans from the Bundestag led to a weaker performance of bunds versus gilts, leading to an attractive level to remove the cross-market position, which contributed positively to performance.

We started the quarter with an overall duration positioning of 1.50 years overweight relative to the benchmark. Despite 10-year gilt yields moving around 10 basis points higher over the quarter, we maintained our overall position, as we believe weakness in the UK economy will feed through and contribute to falling rates faster than the market expects. The Fund benefitted from having UK exposure through the 10 year rather than shorter-dated gilts; the 2-year bond yield rose by 20 basis points.

Credit Performance

The fund’s credit positioning had a positive impact on the Fund’s performance, which came from both sector and security selection. In general, UK credit saw a mild spread widening from the tights at the start of the year.

Within our portfolio, both sector and stock selection contributed positively. Our overweight in insurance and underweight in utilities delivered strong sector performance. Our overweight position in telecoms was a slight detractor from performance; however, that was offset by strong stock selection within the sector. Also, security selection within real estate, industrial, banks and insurance contributed positively to performance, given our exposure to higher quality names in our favoured sectors.

Within utilities, stock selection negatively impacted performance, as Southern Water came in from the wides. We are not convinced in a turnaround plan from current weak performance for the company without significant additional equity, so maintain the decision not to hold the name.

We have also been marginally reducing our credit spread duration over the quarter, which is now slightly underweight relative to the benchmark. This move led to the Fund being more insulated from the negative credit moves over the period.

Trading Activity

Trading activity varied throughout the quarter. Opportunistic issuance and tight valuations made way for geopolitical uncertainty as issuers stepped back from markets. We took advantage of tighter spreads to take risk out of the portfolio, supporting performance towards quarter-end.

Given the relatively flat credit curves earlier in the quarter, we took the opportunity to reduce spread  duration across a number of names, including Credit Agricole, Zurich, HSBC, SSE, Anglian Water and Places for People. For Places for People, we did this through participating in a new issue, rotating out of our existing holding to the shorter-dated new issue at attractive terms.

Outside of shorteners, we also made a number of relative value trades. In the banks space, we switched from Lloyds into BNP Paribas for a 2-notch uplift in rating and pickup in yield. Following the outperformance of our Barclays holding, we switched into KBC Group, which is a lower beta name with better sustainability credentials.

We added a number of new holdings over the quarter. We added a new holding in Sage, who provide accounting, payroll and HR solutions to small and medium-sized enterprises. Enabling these firms promotes competition by giving them similar tools to larger corporations, creating more resilient employment and economies. We initiated a position after spreads were driven wider on new issuance from the company. The new issue was funded by trimming some of our Telecommunications holdings, with our holdings having performed well versus the benchmark. Elsewhere, we added a 7 year bond from the German electricity distributor E.ON, which is attractively valued relative to its UK-based peers.

We also participated in a new issue from the Climate Investment Fund, which raises funds in order to provide resources that scale up low carbon technologies and support clean technologies in low and middle-income countries. We funded the position from our gilt allocation, as the name is an opportunity to take sovereign-like risk for an additional yield pickup.

Outlook

We remain reasonably constructive on the outlook for corporate bonds based on attractive all-in yields and the carry from spread currently on offer. We are cognisant of the tightening we have seen over from the wides over the last couple of years, and as such have been taking opportunities to increase credit quality and reduce spread duration. Recent political developments and trade policies have led to a decompression in spreads and have caused volatility in the markets. We think that many of our high-quality corporates have solid fundamentals, and we may take the opportunity to add to credit exposure again on any further repricing, but remain wary of the volatile backdrop.

There has been a moderation 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, reflecting an increase in debt levels alongside lower EBITDA growth, due to a combination of lower revenue growth and rising costs. However, both of these metrics remain at healthy levels.

We therefore think that additional performance will 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 overweight 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 over 5% still present an attractive opportunity. Currently, our Fund’s gross redemption yield is 5.6%, stemming from high-quality investment grade credit.

For 2025, we expect a low-growth economic environment, and even though markets have been recently challenged with persistent inflation and a narrative of higher rates for longer, we believe the UK will start showing signs of weakening more than the market expects. Growth has disappointed in the latter half of 2024, and the recent market moves could further hamper its progress. With a labour market which looks to be continuing to loosen, and broad economic sentiment foundering, we think yields will end 2025 lower than they have started. Over the longer term we expect gilt yields to fall as the weaker underlying fundamentals in the UK economy come into sharper focus.