Donald Philips joined Liontrust in February 2018 and is co-manager of Liontrust’s High Yield Bond and Absolute Return Bond strategies. He forms part of a team of three, alongside David Roberts, Phil Milburn where together they manage the Liontrust Global Fixed Income Process. Donald was previously an investment manager in the Credit team at Baillie Gifford and worked with David and Phil at Kames Capital for three years from 2005 to 2008. He was co-manager of the Baillie Gifford High Yield Bond Fund from June 2010 to 2017 and the US High yield strategy.
The collective action taken by central banks and politicians to bolster the economy has been huge in scale, which seems appropriate given the unprecedented challenges we face. Indeed, addressing the policy actions that we’ve seen to date, the Liontrust GFI team hosted a conference call on Tuesday 24th March. In short, this time last week, it felt like the credit markets, including bonds of the highest quality, were struggling. Liquidity was extremely poor through Investment Grade bonds into High Yield. However, in recent days after central bank action, which you could describe as throwing the kitchen sink, we have seen much improvement in liquidity for large parts of the market and a rally in bond prices from the lows.
With great uncertainty, we are not calling the end to volatility in our market. However, we have conviction in High Yield’s long-term resilience, and on that basis, we view current valuations as an opportunity for the medium to long-term investor, which I know is a characteristic of the Maltese (as it should be the rest of us!). The following is our response to some FAQs.
With regards to the current market conditions; which sectors/ cos will survive/ thrive or which will not?
Market conditions only a week ago were very challenging, when the High Yield market had fallen around 20% during the crisis. This type of move is certainly not normal for our market but is about in line with what you would expect when equities are down 35-40%. As discussed, the market has stabilised, rallied and sentiment has improved post central bank action.
If the market closes to new issuance for a long period of time, then every sector will have its casualties, as companies fail to refinance debt. We are encouraged that the typical High Yield borrower has pushed its debt profile reasonably far into the future. The High Yield market closed to new issuance for around 18 months in the GFC, if such a bottleneck was to occur now, debt maturities wouldn’t be a problem for the majority of the companies in the market. As you may know, we have a preference in the portfolio for listed companies, which should have more options in term of sources of capital than many private companies.
Similarly, from an operational perspective, the impact of the Pandemic on sectors and individual companies will depend on the timescale before we can get back to some sort of normality. We think two of the best sectors in the HY market best placed to weather the storm is Media and Telecommunications, tow of our largest sector weights. It is likely that demand for telecommunications and content while we are all cooped up at home should be strong. In these sectors we own various high quality company’s bonds, including Vodafone; Charter Communications and Netflix. Elsewhere in Media/Telecom, we hold large national players from Netherlands (Ziggo), Portugal (Altice), various Latam countries (Millicom, our only direct EM holding), AT&T and US regional telecom, Centurylink.
Cyclical sectors in general face an uncertain outlook. Again, the extent of damage sustained will be a function of time. In our stock-picking, we seek resilience. The characteristics we look for in cyclicals, for example, is evidence they can survive painful economic periods. The GFC has been a useful stress test for those companies where we can access historical data. Our preference for listed companies means historical data is typically available.
The most obvious negative impact is in Oil & Gas, particularly with the supply shock that is running alongside the demand shock from the Pandemic. We have four holdings in this sector which represent ~2.5% of NAV. The largest of which, Neptune Energy, is close to 2/3 hedged in 2020 and is predominately gas production.
In our stock-picking and portfolio construction, we seek to reduce thematic risk, so that one particular theme doesn’t swamp our risk and return at a particular time. For example, although the fall in price of our energy holdings has been substantial, versus our index, our Energy sector exposure has been a relative positive contributor as we have a small total exposure. Another ‘theme’ we have avoided is disruption risk in the Retail sector. Therefore we have next to no exposure in traditional bricks and mortar, with our only exposure to the sector a small position in a company consolidating the petrol forecourt retail space, bought into after the selloff started. Similarly, in Autos, we are well positioned against the disruption risk posed my electrification of vehicles. It seems to me that the Pandemic may well act as a catalyst for disruption risk.
After markets decline, where do you see the current market valuation (favourite metric) against longer term median & range?
Our favoured metric in High Yield is to look at ‘spread’, the additional premium earned above government bonds. To gauge our attraction to the market, we exclude Energy and the weakest parts of the market. This is because our research template, the PRISM, points us away from businesses we do not believe to be resilient and therefore there are very few CCCs in the Fund. Similarly, we exclude energy because we do not want this ‘theme’ clouding our view of overall market valuation. The current spread on this custom index is 7%, having been close to 9% only a few days ago. We appreciate the global population and economy faces great uncertainty, but this is a level of spread which offers good compensation versus defaults. The spread has only been through this level a handful of times and each time has provided handsome returns for the medium-long term investor.
What changes have you made pre & post crisis?
When spreads increased above 4%, we increased risk in the portfolio from an underweight position via buying longer dated bonds from some of our preferred companies. In the last couple of weeks, we have been relatively low in turnover. We have recycled risk in a couple of holdings where we wanted to trim the position size, but switched into similarly yielding bonds. We have very light exposure to the lowest quality parts of the market, rated CCC and below.
Are you planning changes, what will trigger them?
No material changes planned.
Any other observations?
High Yield has been through several cycles since its emergence as an asset class in the 1980s and has consistently proven its resilience. Its robustness stems from returns being almost entirely driven by the coupons paid by the companies in the portfolio. The High Yield market has many high-quality companies and we believe we have a portfolio at the higher quality end of the market. During the crisis, the managers have been investing more in the fund personally.
Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.
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