Liontrust Responsible Capitalism Report 2024 - Flipbook - Page 110
Global Fixed Income team’s investment process
STEP
1
ESG-RELATED SCREENING
The team excludes from its investable universe bond
issuers that have involvement with:
• Controversial weapons (cluster munitions, land mines, biological
weapons, chemical weapons, nuclear weapons, white
phosphorous/blinding agents and depleted uranium) (zero
tolerance)
• Civilian weapons (conventional weapons and weapons systems)
• Tobacco products (including the production, distribution, supply
and sale of these) (no more than 5% of annual revenue)
• Thermal coal or own thermal coal reserves (no more than 30% of
revenues from this)
Or which are:
• deemed by MSCI to be non-compliant with the Global Compact
and which have not provided an acceptable explanation or
rationale.
The team also excludes from its investable universe sovereign
(government issued) debt that has an MSCI ESG rating of BB or
lower (these tend to be emerging market issuers where the fund is
not focused)
When considering sovereign debt, the team focuses on G7-issued
debt where transparency is high and the rule of law is applied in
a consistent manner.
QUALITY HURDLE
Once the screens have been applied, the team
undertakes macroeconomic analysis (top down) and
examines issuers (bottom up) for indications of high
transparency, competitive advantages, access to capital and
liquidity, good governance and sustainability factors. The team
uses the same framework to garner a thorough understanding
of the economic environment and for bottom-up stock analysis:
fundamentals, valuations and technicals (FVT). These three factors
are examined regardless of whether the managers are considering
a duration position or an investment in a speculative grade rated
company. For each investment, fundamental, ESG, valuation and
technical factors are considered to ensure consistency in decision
making and to provide a flexible approach to bond investment.
This means that the level of interest rate and credit risk within the
portfolio can be expected to vary materially within the cycle.
be viewed in isolation. Absolute and relative valuations, a second
factor, are considered: is a bond or market cheap in its own right,
and does it offer value against history or any other fixed income
asset? Is the investor being compensated for default risk and is there
a sufficient illiquidity premium in credit spreads?
Technicals comprise the third factor and analysis here helps
determine the timing of entry into and exiting of positions. The
team reviews and analyses sentiment and volatility indicators along
with surveys showing investor positioning. Structural distortions,
such as central bank quantitative easing, are also considered.
The team then conducts a line-by-line review of each of the funds’
investments. This ensures that each holding is still applicable given
the prevailing macroeconomic backdrop and provides a valuable
feedback loop to challenge the team’s top down view. Additionally,
this helps the cross-fertilisation of ideas across the funds, both at the
stock level and through the interpretation and extrapolation of any
of the team’s highest-conviction investment ideas. For example, a
strong view on interest rates can have meaningful ramifications for
banks based in the respective jurisdiction. If a riskier holding is no
longer offering a meaningful upside, the team will look to rotate the
position into a new opportunity. Should significant new information
arise, the team will react quickly to either protect portfolios or take
advantage of market dislocations.
Three key sources of portfolio alpha: rates, allocation and selection
The three main drivers for fixed income portfolios are rates, allocation
and selection. The three categories have numerous alpha sources
underlying them, and the team optimises portfolio positioning by
adjusting these sources of risk and return. They can be used to target
alpha, beta or risk management depending on a fund’s mandate.
STEP
2
The team examines a large range of global macroeconomic
variables comprising both hard (official economic data) and soft
data (forward-looking activity surveys/indicators). This combination
is used to challenge the managers’ macroeconomic view and ensure
central assumptions about growth, inflation and the economic cycle
are still valid. Any topical issues, ranging from sovereign crises to
commodity price fluctuations, can be reviewed within this context
and their potential to have a meaningful impact suitably gauged.
The FVT framework is then applied to the main markets in which
the team invests. Fundamentals, a first factor, are crucial but cannot
110 - Responsible Capitalism Report 2023
Rates
Duration, the interest rate sensitivity of a bond or fund, is one
of the biggest traditional drivers of fixed income performance.
However, there are so many other levers that can be pulled to
aid performance. Yield curve positioning is tremendously useful
through the monetary cycle; frequently when short rates rise,
longer-dated bonds outperform their shorter-dated cousins (the
assumption is the central bank rate rise will reduce longer-term
growth). The managers can capture yield curve positions in a
duration neutral fashion, thereby prioritising rates’ alpha over
beta. Cross-market duration trades across developed economies’
government bonds are a good alpha source.
As well as conventional fixed income securities, the team can also
invest in floating rate debt, which benefits when rates rise, and
inflation-linked securities. The difference between the conventional
bond and the index linked bond’s yield, the breakeven, is another
potential performance source.
For core markets, the rates positioning flows straight from the
FVT framework. To examine cross-market opportunities and yield
curve opportunities, the managers use a quantitative screen.
Fundamental and technical analysis is then married with this to
evaluate whether the valuation anomaly can easily be used to
capture some alpha.