Liontrust Responsible Capitalism Report 2024 - Flipbook - Page 43
Investment process: fixed income
STAGE 1: IDENTIFYING SUPERIOR BONDS
First, the team selects the bonds that it believes will generate superior
investment performance. The team focuses on high-quality issues and
believes this can enable the team to reduce bond-specific risk.
A. Find high quality companies
The team’s assessment of quality is a distinctive part of
the process. It combines credit analysis with in-depth
analysis of issuer-specific factors, including ESG factors
and macroeconomic analysis. The in-house research
includes the following:
ESG analysis
For each company, the team determines the key ESG
factors that are important indicators of future success,
and assesses how these are managed. The team
does this through its proprietary sustainability matrix,
which is used by both the bond and the equity teams.
Where relevant, the team aims to identify companies
whose core products or services are making a positive
contribution to society or the environment in some way.
The team believes that evidence of excellent company
management is instrumental to avoiding issues where tail risk
is under-priced. Reducing tail-risk is a key element that drives
long-term returns in the team’s bond portfolios.
Credit analysis
This involves a fundamental review of the company to identify its
ability to meet its debt obligations. The team looks at:
• The company’s management in terms of its track record, its
consistency, level of cross-involvement, level of control exercised
and make up of nonexecutives
• Company performance from earnings stability to growth
patterns to relative performance and pricing power
• The business strategy such as its investment strategy, funding
and foreign currency policy, type of growth (e.gg. M&A versus
organic) and the business risk
• Industry factors including barriers to entry, and industry threats
and patterns
Macroeconomic analysis
Here, the team formulates strategy by looking at the interest
rate positioning, asset allocation and aggregate credit rating
exposures based on macro views. This approach ensures that
the investment process remains balanced, incorporating top-down
views as well as bottom-up analysis.
The team also incorporates other macro influences into the
analysis, including political factors, economic analysis, regulatory
issues and ESG analysis. For government bonds, this involves
a review of the sovereign from an ESG perspective in order to
assess its suitability for investment. MSCI Sovereign rating data
is used as an input into the process, overlaid with the team’s own
analysis. The team specifically focus on the following:
• Environment – fossil and nuclear fuel usage, water usage,
energy management and CO2 and GHG emissions
• Social – education and technology, provision of basic needs and
the economic environment
• Governance – financial capital and management, political
governance and democratic rights
• Controversies – general controversies, involvement in armed
conflicts and international sanctions
This information is distilled into a sovereign rating (completed
annually) and presented to the broader team for discussion and
approval.
B. Assessing returns versus downside risk
The fund managers assess individual bonds to determine whether
they believe the bonds offer attractive, long-term returns. However,
given the asymmetric risk associated with corporate bond
investing, the probability of default is fully assessed alongside a
view of recovery values for each individual investment.
C. Valuing the bond
Valuations are assessed on the basis of both absolute and relative
returns. Simply put, there is no point in investing in a bond merely
because it is cheap relative to other bonds in the sector if the team
believes that the total returns are not attractive to the end investor.
As such, they look for opportunities across the capital structure of
an issuer and across markets, i.e. the UK, US and Europe. Within
this, the team evaluates the value of a bond relative to both other
corporate and government bonds. This approach is consistent
with the principal aim of delivering attractive long-term returns to
investors.
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