Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.
Quarter 3, 2019 – market review
Having seen strong returns in the first half of 2019, the global high yield market plateaued somewhat in the typically slower summer months, with income driving returns of 1.27% (USD), 0.54% (EUR) and 0.84% (GBP) over the third quarter.
European high yield again had a stronger quarter than its US counterpart, generating a USD return of 2% versus 1.2%. However, the more important story is the persistent outperformance of higher-quality bonds; USD and EUR BBs both outperformed the market with similar returns, carrying on the trend we discussed last quarter. As a reminder, BBs are the most sensitive part of the market to government bond yields, and with ten-year government bond yields falling around 30 basis points in the quarter, BBs benefitted.
With central banks crushing yields, it has pushed some investors into riskier areas. However, it seems high yield investors are not keen at this stage in the cycle to reach too far down the credit spectrum. As a result, we are seeing a growing gap between the yields offered by high and lower-quality high yield bonds. It is perhaps akin to a high yield market version of the growth/value disparity in the equity market.
With a greater proportion of the market made up of lower-quality bond issuers, this is why we see US high yield underperform Europe at the headline level. However, as ever, there is more going on than headlines suggest, which is why it is a great market for stockpicking funds.
Liontrust GF High Yield Bond Fund
The Fund (A1 accumulation class) returned 1.5% in euro terms in Q3 against 0.5% from the ICE Bank of America Merrill Lynch Global High Yield Index (EUR hedged).
Our stockpicking within single B credit, which, as previously noted, generally lagged higher rated BBs, was a major driver of the Fund’s strong performance in the period. For example, USD denominated single B rated bonds held in the Fund like aerospace parts and service company Transdigm (in fact a low single B credit), and US telecom CenturyLink were large positive contributors.
We estimate that around two-thirds of the Fund’s outperformance in the period came from single B rated holdings, which are significantly punching above their weight in the Fund.
We have been dipping our toes in lower-rated high yield credit, with the growing gap in the yield differential between higher quality and perceived low quality creating some opportunities for stockpicking. It is often the case that good-quality business overstretch in terms of their borrowing, perhaps for an acquisition or to distribute capital to owners/shareholders. We tend to like these business so long as we see a good balance of interest between the owners, managers and creditors of the Company.
It is these characteristics we see in French equipment leasing company Loxam, which recently acquired a Northern European peer, investment holding company Softbank and industrial air and gas handling company Howden. The latter is a rare foray (we tend to prefer listed businesses) in a private equity leveraged buyout (LBO), where the new owners have bought this business from one of our existing holdings, industrial company Colfax.
Howden is a cyclical business with a heavily indebted balance sheet. However, it is cash generative and the new owners have paid for a decent amount of the consideration with their own funds, rather than borrowed money. We felt the yield of 11.5% issued in a week when market sentiment was a little wobbly, was a compelling opportunity for what is undeniably a risky holding. Incidentally, we were told that we were the only investor in Europe looking at the Howden new issue.
Each of these new riskier holdings are around 0.75% of the Fund, while we have reduced other riskier holdings, such as oil exploration and production company Enquest at high prices for the year in order to control overall portfolio risk.
The Fund’s holding in petrol station retailer EG Group was short-lived. Soon after the new issue, the company announced yet another large acquisition, with arguably aggressive assumptions behind how much value they can extract from the merger. Our conviction in management weakened and we sold the bonds and only marginally lower than where we purchased them in Q2.
As you know, we try to avoid accumulations of thematic risk in the Fund. Our one exposure to the US energy market Antero Resources, a 0.75% holding in the Fund, was the worst-performing individual stock in the portfolio during Q3, costing an undramatic seven bps in total return. We like Antero because of its hedge position and decent quality assets in the Appalachian region.
However, with US domestic gas prices weak, the sector in general is performing very poorly. Unsurprisingly, as a large component of HY indices, US energy bonds are causing a drag on the returns of index or quasi-index Funds. Happily, our other two energy holdings, which are both North Sea exposed and traded out of London, contributed positively to returns in Q3. As previously mentioned, we reduced Enquest over the period.
At the end of September, the net underlying yield on the Fund was 3.37% (for classes A1, B1 and C1).
Outlook
In the first few days of October, we have seen some weakness in high yield bonds and risk assets in general. Our favoured measure of general market value, the ‘spread’ on bonds excluding CCCs and bonds issued by energy companies has increased by close to 0.6% and is approaching 3.5%.
We believe a 4% spread on this sub-index represents good value for long-term investors and are keeping a close eye in order to increase risk in the Fund. We will be comfortable doing this as although we recognise economic data points to slowing, we believe companies are generally in good shape and a slowdown will represent an earnings squeeze rather than a material increase in default risk for most companies.
As mentioned, we have added a little stock-specific, riskier credit, but at the portfolio level we would still describe our positioning as reasonably defensive. We continue to favour USD-denominated bonds. Fixed income in general, in our view, remains very expensive and we retain our short bias towards duration, or interest rate sensitivity.
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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
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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.
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