Legg Mason Perspectives: EU Fiscal Solidarity

By Andreas Billmeier, Ph.D. – Western Asset

 

Last week’s meetings of European finance ministers were timely, to say the least. As the COVID-19 pandemic spread across the continent, the national policy responses have been uneven, both in terms of timing, but also in terms of budgetary resources committed, ranging from very little in some countries to more than 20% of GDP elsewhere. This partly reflects the (perceived) severity of the crisis but also shows the unevenly distributed fiscal space available in different counties as debt-to-GDP ratios in the larger economies range from about 60% in Germany to 135% in Italy.

Yet, at the same time, the impact in terms of death toll has been much harder on countries like Italy and Spain. Their respective healthcare systems have been put under severe stress and their economies have slumped into deep recessions, likely worse than those experienced in 2008/2009. With less fiscal space at the national level, these countries have led a renewed push for their vision of solidarity, a further liability mutualisation via joint borrowing at the European level, dubbed “Corona bonds”. These countries have been supported by several other member states, including, importantly, France. On the other side of the debate, the EU’s “frugal four” (Austria, Denmark, the Netherlands and Sweden), supported by Germany, have been historically lukewarm about expansionary fiscal policies in general. In fact, these countries have opposed some of the policies quite vehemently, including joint debt issuance. Instead, they perceive existing instruments such as the European Stability Mechanism (ESM) and the associated access to preferential lending as a sufficient display of solidarity, in combination with other measures. In many ways, this is an old discussion; during the European sovereign crisis in 2011/2012, similar suggestions to “Corona bonds” had been floated by some but were opposed by others for fear of open-ended financial commitments.

This inevitably meant that the task at last week’s first conference call of the enlarged Eurogroup finance ministers and the subsequent overtime wrap-up was evidently a tricky one: how to bridge opposing views of solidarity? Can European solidarity only be guaranteed via joint debt issuance or are there other ways to provide adequate support to countries that require more government borrowing but are constrained by their lack of fiscal space? Can solidarity be a loan or does it have to be a grant? The noise level in the press had increased dramatically over the previous few weeks, with recriminations flying back and forth between “the North” (i.e., the frugal four) and “the South” (i.e., Italy and Spain).

European Crisis Response Measures

Against that backdrop, the outcome warrants some attention. The measures that were agreed upon, subject to sign-off by the heads of state where needed, include:

  1. A quick operationalization of the planned European unemployment re-insurance facility known as “SURE” (Support to mitigate Unemployment Risks in an Emergency) to supplement short-time work schemes already in place in all member states. These types of programs have been very successful in avoiding a massive spike in unemployment in some countries during previous recessions, including in 2008/2009, and SURE is intended to bridge member states over the current crisis. The novel element is that the temporary loans come on favourable terms from the European Commission (EC), which, in turn, will borrow up to €100 billion in the markets to benefit from its (potentially) superior credit rating.
  2. Additional guarantees from member states for the EU’s development bank, the European Investment Bank (EIB), to lever up and provide lending on the order of €200 billion to small and medium-sized enterprises (SMEs) and midcap companies in Europe.
  3. A decision to enable borrowing from the ESM under a specific short-term precautionary credit line for the duration of one year (but renewable until the crisis is over). Access granted will be 2% of each nation’s 2019 GDP with a minimal level of conditionality, worth up to €240 billion for the eurozone as a whole. Minimizing the conditionality (simply “to support domestic financing of […] costs due to the COVID-19 crisis”) is a strong positive but still leaves the stigma of accessing the ESM funding. That said, one of the longer-term benefits for member states engaged in ESM programs is the potential eligibility for the ECB’s targeted bond purchase program, Outright Monetary Transactions (OMT), if that were to become necessary.
  4. Finally, the finance ministers have also agreed to work on a Recovery Fund for the period after the acute crisis is over, but the details are still unclear. In particular, the timing and size of this Fund and, more importantly, the financing have been left to further discussions – a reflection of the fact that no agreement could be found at this stage.

Assessing the Measures

The overall sum of measures (€540 billion, or a bit more than 4% of eurozone GDP, not taking into account the Recovery Fund) certainly makes for an impressive headline but the devil is, as usual, in the detail. First, access to SURE and the ESM facility appears to be designed as transitory, and might not come on more attractive terms than market borrowing as long as this is feasible; in fact, to the contrary, given where front-end sovereign curves are currently trading. In other words, the effective resource envelope in use could collapse to something much smaller than €340 billion for those SURE and the ESM. Second, EIB lending is demand driven, and the scaling-up process could take a good amount of time. Finally, while the Recovery Fund (still) has some potential to develop into a true solidarity instrument based on joint borrowing for a joint cause, statements by some of the ministers involved have already sown doubts even before we know any further details.

Forging a joint borrowing capacity with meaningful open-ended commitments by national member states requires overcoming constitutional hurdles—as well as societal opposition—in some member states, and continues to be a bridge too far to cross, even at the current stage. That said, dealing with the fallout from COVID-19 and the ensuing recovery effort is clearly a well-defined public good with massive spillover effects across economies in an integrated area such as the EU and especially the eurozone. Moreover, it is not clear a priori whether export-oriented economies will fare better or worse in this recovery as the world moves toward more robust supply chains—in other words, “winners” and “losers” within the eurozone have yet to be defined.

For those reasons, we think a more convincing public case can and should be made that, in the face of the current crisis, joint financing of at least a limited common recovery effort, such as the one under consideration, should be perceived as true reciprocal solidarity in everybody’s eyes and not just a one-directional transfer scheme as some seem to believe.


Legg Mason Key risks and Disclaimers

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

MeDirect Disclaimers

This information has been accurately reproduced, as received from Legg Mason Investments (Europe) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Market Update by Liontrust – Q1 2020

Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.

Quarter 1, 2020 – market review

The first few weeks of the year saw high yield bond prices creep higher until the pandemic turned the market on its head. March saw the global high yield market produce a return of -12.9% in euros, leading to -14.1% over the quarter. It looked as if returns were going to break the worst month on record (October 2008), but action from central banks and governments, globally, stoked a relief rally.

The US high yield market marginally outperformed its European counterpart. Meanwhile rating bands performed in the manner you would expect, with higher quality outperforming, yet still down double-digit percentages in the BB cohort. The worst-performing sector was energy, which fell over 30% in March.

The Liontrust GF High Yield Bond Fund (A1 accumulation class) returned -14.9% in euro terms in Q1 against -14.1% from the ICE Bank of America Merrill Lynch Global High Yield Index (EUR hedged).

At the end of March, the net underlying yield on the Fund was 6.38% (for classes A1, B1 and C1).

Image 2 Liontrust Q1 2020

Discrete data is not available for five full 12-month periods due to the launch date of the portfolio. *Source: Financial Express, to 31.03.20, A1, B1 and C1 share classes, total return, net of fees and interest reinvested.

Outlook

We are all faced with an extremely uncertain outlook. At times like this, I like to consider the resilience that high yield has shown in previous cycles. For example, our favoured sub-set of the market, excluding CCCs and energy, has a spread of 715 basis points (bps) as I type. Historically, when the market has pushed through 700bps, the return profile of a medium to long-term investor committing capital on that day has been excellent, as the chart below highlights.

 

Image 1 Liontrsut Q1 2020

As the economy deteriorates, defaults are clearly a risk to high yield returns. In early April, JPM published a note to clients indicating they expect the European high yield market to have 6% defaults as a base case for 2020. That would be a quicker impact than in 2008 when defaults did not peak until the following year but if we expect a shorter, sharper downturn this time, I would not quibble with that number too much.

If we take that 6% as a starting point, the US high yield market, with its high exposure to the domestic energy sector, could well be higher than that.

We are encouraged that of all the sub-investment grade debt that comes due between 2020-2024, only 4% is to be repaid in 2020 and 68% in the final two years (2023 and 2024). This provides a good degree of cushion against refinancing risk.

The next obvious risk is an inability to service interest payments and this is partially captured within credit ratings. Currently, 86% of our portfolio is in mid-B rated credit and higher: according to Moody’s in mid-February 2020, only 16% of companies rated B2 had weak interest cover and cashflow metrics and this proportion gradually drops as we move towards the higher rated parts of the market.

Of course, the economic impact is going to be huge in the near term and those company metrics will change rapidly. We are comforted, however, that the Fund does not have significant exposure to thematic and cyclical sectors such as energy, mining, leisure and retail. For example, the Fund has 0.4% in retail (petrol forecourt), around 2% in energy, 1% in mining and 0.5% directly in casinos/hotels/tourism.


Liontrust Key risks & Disclaimers:

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not
guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. 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.

Investment in the GF High Yield Bond Fund involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income
securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate
of interest. Bond markets may be subject to reduced liquidity. The Fund may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may
have the effect of increasing volatility.

Issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated
investment business.

This document 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. 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. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust.
Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Liontrust Fund Partners LLP. No information has been omitted which would render the reproduced information
inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information
purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available
in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding
the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at
the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this
investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The
performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest
should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Legg Mason Perspectives: EU Fiscal Solidarity

By Andreas Billmeier, Ph.D. – Western Asset

 

Last week’s meetings of European finance ministers were timely, to say the least. As the COVID-19 pandemic spread across the continent, the national policy responses have been uneven, both in terms of timing, but also in terms of budgetary resources committed, ranging from very little in some countries to more than 20% of GDP elsewhere. This partly reflects the (perceived) severity of the crisis but also shows the unevenly distributed fiscal space available in different counties as debt-to-GDP ratios in the larger economies range from about 60% in Germany to 135% in Italy.

Yet, at the same time, the impact in terms of death toll has been much harder on countries like Italy and Spain. Their respective healthcare systems have been put under severe stress and their economies have slumped into deep recessions, likely worse than those experienced in 2008/2009. With less fiscal space at the national level, these countries have led a renewed push for their vision of solidarity, a further liability mutualisation via joint borrowing at the European level, dubbed “Corona bonds”. These countries have been supported by several other member states, including, importantly, France. On the other side of the debate, the EU’s “frugal four” (Austria, Denmark, the Netherlands and Sweden), supported by Germany, have been historically lukewarm about expansionary fiscal policies in general. In fact, these countries have opposed some of the policies quite vehemently, including joint debt issuance. Instead, they perceive existing instruments such as the European Stability Mechanism (ESM) and the associated access to preferential lending as a sufficient display of solidarity, in combination with other measures. In many ways, this is an old discussion; during the European sovereign crisis in 2011/2012, similar suggestions to “Corona bonds” had been floated by some but were opposed by others for fear of open-ended financial commitments.

This inevitably meant that the task at last week’s first conference call of the enlarged Eurogroup finance ministers and the subsequent overtime wrap-up was evidently a tricky one: how to bridge opposing views of solidarity? Can European solidarity only be guaranteed via joint debt issuance or are there other ways to provide adequate support to countries that require more government borrowing but are constrained by their lack of fiscal space? Can solidarity be a loan or does it have to be a grant? The noise level in the press had increased dramatically over the previous few weeks, with recriminations flying back and forth between “the North” (i.e., the frugal four) and “the South” (i.e., Italy and Spain).

European Crisis Response Measures

Against that backdrop, the outcome warrants some attention. The measures that were agreed upon, subject to sign-off by the heads of state where needed, include:

  1. A quick operationalization of the planned European unemployment re-insurance facility known as “SURE” (Support to mitigate Unemployment Risks in an Emergency) to supplement short-time work schemes already in place in all member states. These types of programs have been very successful in avoiding a massive spike in unemployment in some countries during previous recessions, including in 2008/2009, and SURE is intended to bridge member states over the current crisis. The novel element is that the temporary loans come on favourable terms from the European Commission (EC), which, in turn, will borrow up to €100 billion in the markets to benefit from its (potentially) superior credit rating.
  2. Additional guarantees from member states for the EU’s development bank, the European Investment Bank (EIB), to lever up and provide lending on the order of €200 billion to small and medium-sized enterprises (SMEs) and midcap companies in Europe.
  3. A decision to enable borrowing from the ESM under a specific short-term precautionary credit line for the duration of one year (but renewable until the crisis is over). Access granted will be 2% of each nation’s 2019 GDP with a minimal level of conditionality, worth up to €240 billion for the eurozone as a whole. Minimizing the conditionality (simply “to support domestic financing of […] costs due to the COVID-19 crisis”) is a strong positive but still leaves the stigma of accessing the ESM funding. That said, one of the longer-term benefits for member states engaged in ESM programs is the potential eligibility for the ECB’s targeted bond purchase program, Outright Monetary Transactions (OMT), if that were to become necessary.
  4. Finally, the finance ministers have also agreed to work on a Recovery Fund for the period after the acute crisis is over, but the details are still unclear. In particular, the timing and size of this Fund and, more importantly, the financing have been left to further discussions – a reflection of the fact that no agreement could be found at this stage.

Assessing the Measures

The overall sum of measures (€540 billion, or a bit more than 4% of eurozone GDP, not taking into account the Recovery Fund) certainly makes for an impressive headline but the devil is, as usual, in the detail. First, access to SURE and the ESM facility appears to be designed as transitory, and might not come on more attractive terms than market borrowing as long as this is feasible; in fact, to the contrary, given where front-end sovereign curves are currently trading. In other words, the effective resource envelope in use could collapse to something much smaller than €340 billion for those SURE and the ESM. Second, EIB lending is demand driven, and the scaling-up process could take a good amount of time. Finally, while the Recovery Fund (still) has some potential to develop into a true solidarity instrument based on joint borrowing for a joint cause, statements by some of the ministers involved have already sown doubts even before we know any further details.

Forging a joint borrowing capacity with meaningful open-ended commitments by national member states requires overcoming constitutional hurdles—as well as societal opposition—in some member states, and continues to be a bridge too far to cross, even at the current stage. That said, dealing with the fallout from COVID-19 and the ensuing recovery effort is clearly a well-defined public good with massive spillover effects across economies in an integrated area such as the EU and especially the eurozone. Moreover, it is not clear a priori whether export-oriented economies will fare better or worse in this recovery as the world moves toward more robust supply chains—in other words, “winners” and “losers” within the eurozone have yet to be defined.

For those reasons, we think a more convincing public case can and should be made that, in the face of the current crisis, joint financing of at least a limited common recovery effort, such as the one under consideration, should be perceived as true reciprocal solidarity in everybody’s eyes and not just a one-directional transfer scheme as some seem to believe.


Legg Mason Key risks and Disclaimers

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

MeDirect Disclaimers

This information has been accurately reproduced, as received from Legg Mason Investments (Europe) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Market Update by Liontrust – Q1 2020

Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.

Quarter 1, 2020 – market review

The first few weeks of the year saw high yield bond prices creep higher until the pandemic turned the market on its head. March saw the global high yield market produce a return of -12.9% in euros, leading to -14.1% over the quarter. It looked as if returns were going to break the worst month on record (October 2008), but action from central banks and governments, globally, stoked a relief rally.

The US high yield market marginally outperformed its European counterpart. Meanwhile rating bands performed in the manner you would expect, with higher quality outperforming, yet still down double-digit percentages in the BB cohort. The worst-performing sector was energy, which fell over 30% in March.

The Liontrust GF High Yield Bond Fund (A1 accumulation class) returned -14.9% in euro terms in Q1 against -14.1% from the ICE Bank of America Merrill Lynch Global High Yield Index (EUR hedged).

At the end of March, the net underlying yield on the Fund was 6.38% (for classes A1, B1 and C1).

Image 2 Liontrust Q1 2020

Discrete data is not available for five full 12-month periods due to the launch date of the portfolio. *Source: Financial Express, to 31.03.20, A1, B1 and C1 share classes, total return, net of fees and interest reinvested.

Outlook

We are all faced with an extremely uncertain outlook. At times like this, I like to consider the resilience that high yield has shown in previous cycles. For example, our favoured sub-set of the market, excluding CCCs and energy, has a spread of 715 basis points (bps) as I type. Historically, when the market has pushed through 700bps, the return profile of a medium to long-term investor committing capital on that day has been excellent, as the chart below highlights.

 

Image 1 Liontrsut Q1 2020

As the economy deteriorates, defaults are clearly a risk to high yield returns. In early April, JPM published a note to clients indicating they expect the European high yield market to have 6% defaults as a base case for 2020. That would be a quicker impact than in 2008 when defaults did not peak until the following year but if we expect a shorter, sharper downturn this time, I would not quibble with that number too much.

If we take that 6% as a starting point, the US high yield market, with its high exposure to the domestic energy sector, could well be higher than that.

We are encouraged that of all the sub-investment grade debt that comes due between 2020-2024, only 4% is to be repaid in 2020 and 68% in the final two years (2023 and 2024). This provides a good degree of cushion against refinancing risk.

The next obvious risk is an inability to service interest payments and this is partially captured within credit ratings. Currently, 86% of our portfolio is in mid-B rated credit and higher: according to Moody’s in mid-February 2020, only 16% of companies rated B2 had weak interest cover and cashflow metrics and this proportion gradually drops as we move towards the higher rated parts of the market.

Of course, the economic impact is going to be huge in the near term and those company metrics will change rapidly. We are comforted, however, that the Fund does not have significant exposure to thematic and cyclical sectors such as energy, mining, leisure and retail. For example, the Fund has 0.4% in retail (petrol forecourt), around 2% in energy, 1% in mining and 0.5% directly in casinos/hotels/tourism.


Liontrust Key risks & Disclaimers:

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not
guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. 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.

Investment in the GF High Yield Bond Fund involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income
securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate
of interest. Bond markets may be subject to reduced liquidity. The Fund may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may
have the effect of increasing volatility.

Issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated
investment business.

This document 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. 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. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust.
Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Liontrust Fund Partners LLP. No information has been omitted which would render the reproduced information
inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information
purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available
in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding
the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at
the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this
investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The
performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest
should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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We strive to ensure a streamlined account opening process, via a structured and clear set of requirements and personalised assistance during the initial communication stages. If you are interested in opening a corporate account with MeDirect, please complete an Account Opening Information Questionnaire and send it to corporate@medirect.com.mt.

For a comprehensive list of documentation required to open a corporate account please contact us by email at corporate@medirect.com.mt or by phone on (+356) 2557 4444.