Lower-quality bonds again continue to dominate returns in the market, materially so in the first quarter. The global high yield market produced a return of 0.71% (US dollar terms) with BBs registering a small negative return (-0.18%) and CCCs producing close to 5%. Single Bs returned 1.18%.
A dominant theme in the strong performance of bonds with low credit ratings has been their relatively low interest rate sensitivity. For example, the small negative return from BBs is illustrative of the interest rate risk that exists in this cohort, whilst the strong performance of CCCs shows that lending to such companies is entirely down to credit risk. That being said, with yields on 10-year Treasuries around 0.65% higher than at the start of the year, indicative of capital losses of around 4.5%, the returns from BB bonds have been fine in our view given the adjustment to higher rates we have seen in the market. We are, after all, only talking about a three-month period.
Sectors performed along the lines of their duration and credit quality profiles, with the likes of energy, which makes up a decent proportion of CCCs, performing well, and media, where longer duration bonds are well represented, lagging.
Over the quarter, the Liontrust GF High Yield Bond Fund (A1, accumulation class, total return in euros) produced a return of 1.0% versus the ICE BAML Global High Yield index’s (euro hedged) 0.5%*.
Good stockpicking in the energy sector played a meaningful role in our Q1 outperformance. For example, long-term holding, North Sea producer Enquest, which lagged many of its US equivalents in 2020, has seen its bonds produce strong returns in 2021 to date, with the market apparently coming around to its merits, generating around a 27% return, when energy in general produced around 3.5%.
An attribution of the Fund’s returns in Q1 also shows some of our longer-dated telecom, media and healthcare bonds acting as a drag on performance. For example, the combination of Charter, DaVita, Level 3, Virgin Media and Ziggo, all longer-dated, higherquality bonds, ‘cost’ the Fund around 27 basis points (bps) on a relative basis during the quarter. However, we were conscious of the duration characteristics of these bonds and increased our short duration hedges. Hedges made a positive contribution of around 20bps during the period.
During the quarter, we participated in new issues from Ahlstrom, a fibre-based materials (packaging) company, Brundage-Bone, a construction services business, and Burford, a specialist financier in the litigation finance niche. Two out of three are listed companies and the one non-listed is a combination of private equity and family ownership.
We also purchased bonds issued by rigid plastic packaging company Kloeckner Pentaplast a few weeks after the new issue launch. Although broadly liking the business, we had some doubts over the highly levered capital structure combined with very weak contractual protections and therefore did not buy the bonds at launch. However, the bonds sold off considerably in the first few weeks of their existence for no obvious fundamental reason, and we decided to take a small holding with bonds yielding around 8.25% (issued at 6.5%).
We exited Progroup (small holding, little yield/upside), Colfax (a similar picture), OSB (acquired by investment grade-rated peer) and United Rentals. The latter was a relatively higher-duration bond with unattractive relative value. We also reduced holdings in Charter, Level 3 and DaVita for similar reasons. The rise in yields has squeezed the spread compensation offered by these bonds, making them less attractive. To reiterate, our short-duration hedges cushioned some of the impact higher rates had on the value of these bonds.
We continue to view Fund returns of around 5% as our base case. Note this is in the context of a quality bias and an avoidance of cyclical, thematic sectors that can so often come with concentrated default risk.
High yield has proven itself resilient to rising interest rates, particularly so at the lower quality end of the market. In our view, removing duration risk by investing heavily in the lower -quality end of the market is akin to jumping out of the frying pan and into the fire. Of course, the economic outlook looks pretty good, but surprises usually come to remind us that risk assets come with volatility and risk of capital loss. Although volatility is a reality of the high yield market, we believe the Fund has a relatively low risk of material capital loss due to the aforementioned quality bias and lack of thematic cyclicals. We are not going to chase the low-quality end of the high yield market. Frankly, our clients would be better buying
value equities, in our view. We like the 5% return outlook for the Fund, given these characteristics.
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.
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