A consistent theme in the last four quarters has been the outperformance of low-quality bonds. This trend continued in Q2, as CCCs produced an average return of 4.5%, while the market in general produced a return of 2.4%, with US high yield returning 2.8% and Europe returning 1.6% (all in US dollars).
Boosted by a healthy and stable oil market in recent months, the energy sector was the biggest contributor to index returns with, for example, the US energy sector producing a return of 6.1% in the quarter. The energy sector is a much higher proportion of US high yield than its European counterpart, which helps to explain the US outperformance.
The outperformance of lower-quality high yield continued right up to the end of the quarter, when equity markets were selling off on variant concerns and the strong bid for treasuries continued. Are we living in strange times?
Over the quarter, the Liontrust GF High Yield Bond Fund (A1, accumulation class, total return in euros) produced a return of 1.5% versus the ICE BAML Global High Yield index’s (euro hedged) 2.2%*.
The main drag on relative performance was simply not owning enough energy-related bonds. Although the Fund’s two holdings, Enquest and Neptune, contributed positively, good returns from these bonds were not enough make up for our large underweight to this sector. As a reminder, we seek to avoid large accumulations of risk in thematic, cyclical sectors, regardless of the index. Therefore, it is to be expected that relative performance will be impacted when the energy sector is the standout.
The next biggest detractor on both a relative and absolute basis was the Fund’s holdings in Bausch Health. Bausch surprised the market by announcing a more aggressive attitude towards debt in its forthcoming reorganisation, which led to its various bonds selling off in the range of 6-7 percentage points, a meaningful amount given the stable returns and lack of volatility in the wider market. Although not ideal, we believe Bausch will seek to quickly reduce debt following the reorganisation, which includes selling its eyecare business, and we are happy to hold on to the position with the bonds yielding around 6%.
More positively, the Fund benefitted from good performance from bonds we’ve added in the relatively recent past such as travel and insurance company Saga, packaging company Kloeckner and specialist financer Burford. Meanwhile, high conviction holdings such as Ardagh (packaging), AMS (sensors), Cheplapharm (pharma) and IMA (packaging machinery) were amongst the highest individual positive contributors to returns.
We view a return of nearly 2% return in the quarter and over 3% year to date, as a pretty good performance from the Fund and asset class in the wider context of bond returns so far in 2021. Of course, high yield is largely about credit risk rather than interest rate risk, providing a resilience in a world which has the spectre of inflation.
To the extent that there is interest rate risk in the high yield market, we have managed the Fund with some hedges in place since the start of the year in order to protect returns in the event of a rising interest rate environment. In Q2, these hedges cost the Fund around 0.11%, with US interest rates in particular lower than they were three months ago.
During the quarter, portfolio activity has been relatively modest. We participated in new issues from telecoms giant Vodafone, listed US payments technology company Paysafe and a blood plasmaspecialist pharma company called Kedrion.
At the margin, despite high yields being ever harder to come by, we have reduced exposure to some of our riskier, higher yielding holdings. For example, we reduced the holding in oil producer Enquest from 1.75% to 1.25% and have cut CCC rated Kloeckner to 0.5% from 0.75%, taking profits.
With yields and spreads compressed, we view carry as the main source of returns in the second half of the year. We remain reluctant to chase yield and, as noted, at the margin have reduced exposure to companies that would be most vulnerable if economic conditions were to worsen. Of course, that is not our base case as economic conditions are improving – heating up even – as the increasingly vaccinated population tiptoes back to normality. Rather, the extra compensation for lending to less resilient companies is now wafer thin, and we would rather not take outsized risks with clients’ money for an extra 1-2% yield.
The yield on the Fund is low by historical standards but reasonable compared to the current available, liquid alternatives. Rest assured that we are sticking to our process and philosophy and quality bias. The Fund has recently reached the milestone of its three-year anniversary. We would like to take this opportunity to thank clients for supporting the Fund. As ever, we seek to continue to produce good investment performance and do so in a manner consistent with our process and philosophy.
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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