Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.
Quarter 4, 2018 review
The global high yield market produced a total return of -3.4% in US dollar terms (-4.7% in euros) in the fourth quarter of 2018, with US and European bonds both falling in similar fashion. To put that in context, it was the worst return since the third quarter of 2015 and, like then, the oil price was key.
Within that total return, average high yield bond prices dropped close to 5.0%, with the income typically associated with owning these bonds cushioning the blow. Overall, the global high yield market returned -1.9% in dollar terms over 2018 (-4.2% in euros) and given an average price drop of 8.1%, the value of that income cushion is clear.
I believe the income-generating nature of high yield and the resilience it provides really shines through in years like we have just gone through.
Alongside fears over the growth-choking impact of higher interest rates and increased protectionism (the US versus China, Brexit and a populist Italian government), oil prices were firmly back on investors’ radar in 2018, contributing to this period of higher volatility and lower high yield prices.
Followers of the high yield market will know the last period of material volatility (2015/2016) was catalysed by a drop in the oil price: unsurprisingly then, the near-35% decline in oil prices during Q4 2018 had a significant impact on sentiment.
It is worth noting that corporate cost profiles have improved in recent years, affording companies in general a little more resilience to deal with lower oil prices. Oil remains a key thematic risk for the high yield market however, as the energy sector is around 9% of the global index, a slightly bigger proportion than it was in mid-2015.
Without such material exposure to energy or lower-rated bonds, the European high yield market was notable during the quarter for moves based on disappointing earnings. During company earnings season, it felt like there was a new headline every few hours with specific bond prices routinely dropping multiple percentage points (affected names included restaurant chain Pizza Express, travel agent Thomas Cook, food producer Boparan, lottery and gaming service provider Intralot and metal producer Nyrstar).
Thankfully however, company earnings remain in generally good condition.
Outlook for 2019
At the start of 2018, the global high yield market was expensive with a yield of 5.2%. This included an additional premium for default risk, or spread, of 3.5% over a government bonds yield of 1.7%.
Fast forward to the end of 2018 and after a difficult year, the market has moved to a yield of 7.5% in dollars (just above 4.3% in euros), comprising a spread of 5.4% and underlying government yield of around 2.1%. In a year where high yield, thanks to income generation, has produced only a small negative return, the market has transitioned to a valuation we believe to be attractive and as a team, we have been adding high yield risk across our funds in recent weeks.
I have mentioned the word volatility a few times. To provide some context, a well-known measure of equity volatility which can be used as a proxy for high yield – the VIX index – doubled over the first half of October. Despite that, it is important to remember the rhetoric used to describe the market can be a little exaggerated. Undoubtedly, Q4 was more volatile than in recent years, but the average in the quarter, as measured by the VIX, was in line with the index average going back to 1990: higher than we have got used to recently but not out of the ordinary.
We think volatility comparable to long-term history is here to stay and the lower levels witnessed in much of the last five to eight years were the anomaly. Our response to this is to maintain a portfolio of companies with the right combination of assets, growth prospects, pricing power and access to capital. This leads us away from the lower-quality parts of the market and that currently represents only 2% of the Liontrust GF High Yield Bond Fund.
Our reason for this is based on the fact the default rate is the crucial determinant of value in high yield over the long term. By focusing on our investment decisions, we believe we can minimise defaults and keep a calm head during periods of weaker sentiment.
In the meantime, a starting point of a yield in excess of 7.5% is enough to justify an increased allocation to high yield in 2019 and beyond.
Recent comments from the US Federal Reserve – with chair Jerome Powell seeming to soften on further interest rate rises – are supportive in the short term for risk and positive for our high yield purchases. Euphoria may not last however so we are wary about calling the bottom. What we can say is that for the first time in several years, we can look clients in the eye and recommend high yield.
As at the end of December 2018, net underlying yields on the GF High Yield Bond Fund was 6.31% (for classes A1, B1 & C1).
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.
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