Liontrust Sustainable Future Corporate Bond fund: February 2023 update

• This fund’s managed by an experienced team that’s passionate about sustainability
• They avoid ‘sin stocks’ and invest in bonds issued by companies making a positive environmental or social difference
• The fund’s done well over the long term, marginally outperforming the peer group since Steven became manager in August 2012
• The fund was recently added to the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Liontrust Sustainable Future Corporate Bond fund aims to deliver a combination of income and capital growth over the long term by investing mostly in sterling-denominated, investment grade corporate bonds. The fund excludes areas some may find unethical, such as tobacco, coal and armaments and invests mostly in companies making a positive difference to the environment or society. This means the fund will perform differently to peers at times, so could offer some diversification to a traditional fixed income portfolio. It could also help to diversify a portfolio focused on other assets, such as company shares. More broadly, it could be considered for corporate bond exposure, but with a sustainability focus.

Manager

The fund’s run by a team of four investment managers: Stuart Steven, Kenny Watson, Aitken Ross and Jack Willis. Steven leads the team as Head of Sustainable Future Fixed Income. He’s managed fixed income funds at a number of companies over the years, including Britannic Asset Management, Legal & General and Scottish Widows. He joined Alliance Trust Investments in 2009 and began managing the SF Corporate Bond fund in August 2012. Alliance Trust Investments was acquired by Liontrust in April 2017.

Co-manager Watson began managing fixed income funds in 2004, and Ross and Willis have researched and analysed fixed income investments since 2012 and 2016 respectively. Like Steven, the trio joined Liontrust when it acquired Alliance Trust. The four managers, and three other colleagues, form the small but focused Sustainable Future Fixed Income team.

Alongside this fund, the team also manages the Liontrust Monthly Income Bond fund and the Liontrust GF Sustainable Future European Corporate Bond fund, as well as the fixed income sleeves of a small number of multi-asset funds. We think this is a reasonable workload given the portfolios are similarly managed.

The team can also draw on an Independent Advisory Committee, which is an external panel of sustainability experts who provide feedback on the investment process, highlight areas for improvement and act as an additional level of oversight.

Process

The fund is part of Liontrust’s Sustainable Future range of funds. These funds aim to help create a cleaner, safer and healthier society for the future and generate attractive returns for investors. The managers believe investing in sustainable companies provides greater return potential, and less risk, than other companies, and that many other investors fail to value the sustainability of a business correctly.

Their investment process revolves around a quarterly strategic outlook meeting, where the managers form their views on the future direction of economic growth, interest rates and inflation. This helps shape the way they construct the fund, and how much risk they’re willing to take. The team also conducts more frequent meetings to review positioning, discuss new opportunities and identify new risks.

Sustainability and ESG analysis is fully integrated into the team’s investment process. They aim to identify bonds issued by high-quality companies whose core products or services make a positive contribution to society or the environment. This sustainability analysis is completed within the team for every bond issuer in the fund.

The fund also employs negative screening. This means it won’t invest in any company that makes more than 5% of its revenues from alcohol, animal testing services, coal, oil & gas, gambling, intensive meat and fish farming, nuclear, ozone depleting substances, pornography, tobacco or weapons systems.

While the managers use this process to find high-quality companies, that doesn’t mean they only invest in bonds with very good credit ratings. Once the team find a high-quality company, they then consider all of the different bonds issued by the companies and invest in those which they believe will provide the best returns. This often leads the fund to have lots of investments in BBB rated bonds, which is the lower end of the investment grade category. This will sometimes result in the fund having higher volatility than the benchmark or peers, particularly over shorter time periods.

The fund’s four managers each have different specialisms. Steven focuses on portfolio construction and banks, Watson focuses on utilities, retail, household goods, travel and leisure, Ross looks at insurance and financial services, and Willis covers telecoms, property, healthcare, industrials and chemicals. Steven and Ross specialise in interest rate management, and Watson and Willis look after credit positioning. Steven has the final say over the portfolio’s overall risk positioning. There is a fair degree of coverage overlap, which leads to a good amount of discussion and challenge amongst the team.

Banks, utilities, insurance and telecoms are some of the fund’s largest sector exposures, but there’s a broad spread of investments across a variety of sectors to ensure diversification. The managers are currently running the fund with more sensitivity to interest rate rises (higher duration) than its benchmark, the iBoxx Sterling Corporate All Maturities Index, because of their view that interest rates are more likely to fall than rise from here over the long-term.

More recently the team have invested in bonds from Zurich Insurance Group, which is a favoured issuer for the managers due to a strong competitive advantage both in terms of sustainability and the broader business. They also invested in a sustainability-linked new issue from Compass Group, a catering and support services company.

They sold investments from issuer Haleon on concerns over future litigation around one of their drugs Zantac. In the banking sector the team rotated out of some of the lower coupon bonds that had been in the fund so that they could reinvest the money into higher coupon new issues from 2022.

The managers have the flexibility to invest in derivatives and emerging markets which, if used, adds risk.

Culture

Liontrust gives managers the freedom to manage their funds according to their own investment and market views. The company simply asks managers not to deviate from their investment processes. Each manager's funds are regularly checked by other senior managers at Liontrust to ensure they're staying true to their investment processes.

We like that all Liontrust fund managers invest a significant amount of their own money into the funds they run, and their incentivisation is tied to the performance of the funds they manage. We think these factors help to align their interests with those of investors.

ESG Integration

The freedom afforded to fund managers at Liontrust means there are no top-down views imposed on managers, so the quality of ESG (Environmental, Social and Governance) integration varies across the firm. That said, the firm’s Sustainable Future range of equity and fixed income funds incorporate ESG analysis in a robust way. We like that individual managers have full responsibility for the investments under their coverage, undertaking the sustainability and ESG analysis, as well as the more traditional company analysis. The same manager also spearheads any engagement that takes place with the companies they cover – it’s not farmed out to a separate Stewardship team. It’s clear that the team regards sustainability and ESG as key parts of the investment process, and it’s considered with the same level of importance as the more traditional financial analysis.

The team produces regular insight articles, available via the Liontrust website. They also produce a detailed annual Engagement and Voting review, and a Sustainable Investment Annual Review, which explores the team’s views on a variety of sustainability-related issues.

Cost

This fund has an ongoing annual charge of 0.56%. The HL platform fee of up to 0.45% per year also applies.

Please note that charges are taken from capital, which could boost the income, but reduces potential for capital growth.

Performance

The Sustainable Future Fixed Income team began managing the fund in August 2012 and since then it’s returned 33.34%* to the end of January 2023, compared to the average return of funds in the IA £ Corporate Bond sector of 32.25%. Remember, past performance is not a guide to the future. Like all funds, the value could fall as well as rise so investors could get back less than they invest.

Over the 12 months to the end of January 2023, the fund underperformed the IA £ Corporate bond peer group average.

The biggest negative impact on peer group relative performance was the fund’s investments in bank bonds. While some of their bank bonds performed well, many struggled for different reasons that were specific to the individual banks or bonds held. An example is a bond issued by bank Standard Chartered. The business had tried to change the conditions of the bond, which would have undermined many investors’ rationale for investing in it in the first place. The price of this bond suffered as a result, however these changes were not accepted and the bond has recovered from its lows.

Investments in real estate bonds also hurt fund performance because the market environment of high inflation, increasing interest rates and the threat of recession is challenging for the sector. An investment in a bond issued by Aroundtown SA, a real estate company specialising in European property, underperformed as management changed its position on refinancing. This combined with increasing governance concerns caused the team to sell the bond.

It wasn’t all bad though, with the fund’s duration positioning adding to returns over the period. Duration is a measure of how sensitive the fund is to interest rate changes, the lower the duration value, the less sensitive the fund is to interest rate changes. The fund had lower sensitivity to interest rates in early 2022 when interest rates rose, which added value. As bond yields increased significantly later in the year, the team increased the funds’ duration and now have a greater sensitivity to future interest rate changes than their benchmark. While the team timed these changes well and this was a beneficial for performance, it was not enough to offset the relative losses from other investments.

It’s worth noting the fund’s ESG exclusion criteria means it’s a different proposition to many in its peer group. This means the fund will perform differently to peers in the IA £ Corporate Bond sector, and its benchmark, at times. When the excluded areas are out of favour and their prices fall, the fund could do well. When they perform well, the fund will miss out. We ultimately think the managers have the potential to reward those who are prepared to take a long-term approach, although there are no guarantees.

The fund was also more volatile than the average funds in the IA £ Corporate Bond sector over the 12 months to the end of January 2023. The fund has more invested in BBB rated credit than many of its peers. As this is at the lower end of the investment grade credit ratings, these bonds are often more volatile during periods of significant market stress such as 2022.

Within the universe of responsible fixed income funds, we have conviction in this one, but there are also other Corporate Bond funds on the Wealth Shortlist without strict exclusion criteria that may offer superior performance potential.

At the time of writing, the fund pays a yield of 3.61%, although yields are variable, not guaranteed, and yields are not a reliable indicator of future income.

Past performance is not a guide to the future. Source: *Lipper IM to 31/01/2023.

MORE ABOUT Liontrust SF Corporate Bond, INCLUDING CHARGES

Liontrust SF Corporate Bond Key Investor Information