Liontrust Sustainable Future Corporate Bond Fund

• UK and US bond markets were driven by softer data, political developments and shifting rate expectations, with central banks delivering rate cuts amid cautious guidance.
• Euro area bonds moved from stability to caution as the ECB held rates, upgraded projections and global rate moves pushed Bund yields higher late in the quarter.
• A strategic long-duration position in UK gilts contributed to outperformance as falling 10-year yields supported strong relative returns.
• Credit markets remained resilient with tight spreads, though an underweight in spread duration and security selection slightly detracted from performance.

Performance

The Liontrust Sustainable Future Corporate Bond Fund returned 3.0%* over the quarter, versus the 2.4% sector average of the IA Sterling Corporate Bond Index and the 2.7% return of the iBoxx Sterling Corporate All Maturities Index, both of which are comparator benchmarks.

Market commentary

UK

UK bonds began the quarter with notable outperformance as yields fell, supported by a combination of softer economic data and fiscal policy developments. A leaked story suggested the Office for Budget Responsibility (OBR) would cut its productivity estimate by 0.3%, tightening the Chancellor’s “headroom” ahead of the Autumn Statement. Meanwhile, private sector wages undershot BoE estimates and inflation surprised to the downside, notably in services and food, which was welcomed by markets.

November was more volatile amid the Budget build-up and a near-constant stream of media speculation. The Bank of England (BoE) had already voted 6–3 to keep rates unchanged, but commentary from some members, including Governor Bailey, hinted that another rate cut could be forthcoming. The data flow was soft: the labour market report disappointed, Q3 GDP growth slowed, and inflation prints were broadly in line with expectations. The biggest surprise came when reports indicated the Chancellor would no longer proceed with income tax rises, following a better-than-expected OBR forecast. Ultimately, the fiscal event – inadvertently pre-trailed by an early release of the OBR’s numbers – showed £21.7 billion of headroom under the fiscal rules, which investors read as a sign of relative fiscal discipline. Consequently, 10-year yields ended the month around 4 basis points higher at 4.49%, having been as high as 4.65% at one stage.

With Budget risks fading, focus in December returned to data and the BoE. Activity data continued to appear lacklustre, with October GDP showing a contraction of 0.1% m/m against expectations of a small expansion. Labour market data was mixed – average earnings beat expectations, but private sector regular pay slipped below 4% and unemployment rose to 5.1%. Inflation fell sharply – headline CPI to 3.2% and services to 4.4% – with clothing and food key drags. Markets were near-certain of a 25 basis point cut, which the MPC delivered (5–4 vote), albeit with cautious messaging on lingering price and wage pressures. Ten-year gilts finished 2025 at 4.54%, up 4 bps on the month and a handful of basis points below the start of the year. 

US

US markets in Q4 were driven by politics, data delays, and shifting rate expectations. In October, a US government shutdown suspended key releases, while President Trump announced further tariffs on China, amplifying political uncertainty. When CPI was eventually published, it came in slightly below expectations at 3.0% for both core and headline, reinforcing expectations for a 25 bp Fed cut, which was delivered. However, Powell’s cautious remarks afterwards cautioned that further easing in December was not predetermined.

This was followed by a series of softer data – weak ISM manufacturing, lower consumer expectations, poor retail sales, and revised payrolls later in the quarter – which bolstered rate-cut expectations. There was no CPI published in November, despite the end of the government shutdown, due to the lack of data collection. In addition, growing expectations of a particularly dovish-leaning Fed Chair to replace Jerome Powell in 2026 helped push yields lower.

In December, the FOMC cut another 25 bp, upgraded growth forecasts, and began T-bill purchases framed as reserve management (not QE). Data, still distorted by the backlog, showed mixed signals in the labour market. There were signs of concentration in the jobs numbers, with most sectors losing jobs and the unemployment rate rising to 4.6%. The BLS reported a two-month CPI change rather than breaking it down into individual months, with headline and core inflation falling to 2.7% and 2.6% respectively. This uncertainty contributed to a muted market, which largely looked through the dovish print, and Treasuries traded in a narrow range. Despite this, 10-year Treasuries closed December at 4.15%, about 40 bp lower year-on-year, a clear outperformer versus many peers.

Europe

Euro area bonds moved from calm to cautious over the quarter. In October, markets steadied despite France’s political whiplash – an abrupt prime ministerial resignation and swift reappointment – while ratings pressure (S&P downgrade to A+, Moody’s outlook to negative) was offset by mildly firmer Q3 GDP at the euro level (+0.2% q/q), headline inflation near target (2.2%, core 2.4%), and an ECB hold at 2.00%. Ten-year Bund yields eased 7 bp to 2.64% and the French–German spread narrowed. Moving into November, price action was subdued as investors modestly reassessed the outlook: Eurostat confirmed October HICP at 2.1%, the November preliminary estimate nudged up to 2.2% with core steady at 2.4%, and ECB minutes characterised risks as “fairly balanced”, keeping policy-on-hold expectations intact. Bund yields finished only around 6 bp higher near 2.70%, with intra-euro spreads well behaved. 

By December, the tone turned more US-like: the ECB again kept rates at 2.00%, but a firmer policy backdrop emerged as staff projections were upgraded (growth to 1.2% from 1.0%, inflation to 2.2% from 1.9%) and hawkish commentary (e.g. Schnabel) coincided with largely in-line inflation (headline 2.1%, core 2.4%). Alongside global rate weakness, this pushed 10-year Bunds up 17 bp to 2.87%, leaving them around 50 bp higher year-to-date, while French spreads remained broadly unchanged despite unresolved budget questions.

Duration

Throughout the fourth quarter, we maintained a strategic long-duration position, implemented exclusively through UK gilts. This contributed to the Fund outperforming the benchmark as UK 10-year gilt yields fell 22 basis points over the period.

At the start of October, the position stood at 1.25 years long relative to the benchmark. During the month, we reduced this to 1.00 year long, as rates moved towards the lower bound of the 4.40–4.80% range. For the remainder of the quarter, we held a 1.00-year duration overweight, with the gilt market remaining volatile and 10-year yields still high.

UK gilts delivered strong returns, ranking as the second-best major sovereign market. Despite inflation remaining above target, softer labour conditions and easing wage pressures allowed the Bank of England to cut rates by 100 bp in 2025.

Credit 

Credit markets remained resilient through Q4, despite occasional pressure from political and fiscal uncertainty. Supportive technical conditions, strong corporate fundamentals, and low global default expectations helped keep spreads tight. The sterling corporate index ended the year at 78, just 5 basis points from its historical tightest level.

Our underweight position in spread duration meant credit slightly detracted from returns as spreads tightened further during the quarter. However, the Fund’s modest allocation to gilts for liquidity and collateral purposes added value as yields declined over the period.

Security selection detracted from performance during the quarter, driven primarily by positions in utilities, banks, and financial services. Sector allocation was broadly neutral. Our underweight allocation to utilities detracted as the sector tightened over the quarter, having previously lagged the index. Security selection was also negative due to outperformance in uninvestible names such as EDF and Southern Water.

Trading activity

Trading activity over the quarter was selective and focused on opportunistic new issues and relative value switches. We participated in attractively priced new issuance, including Inwit, a Verizon hybrid, and a Caixabank bond, funding these through sales of short-dated or higher-priced positions. Within utilities, we extended Anglian Water exposure as the curve steepened and later switched from its operating company bonds into a Holdco tap to reduce duration, while also lengthening United Utilities and rotating from short-dated Unite bonds into Yorkshire Water for a meaningful spread pickup. In insurance, we added to Pension Insurance Corporation for roll-down benefits and switched from Phoenix to Royal London for better value. Financials saw multiple relative value trades, including adjustments in Barclays, BPCE, and BNP, alongside funding for Caixabank. Finally, we exited The Climate Investment Funds – originally a gilt alternative – and used the proceeds to top up long-dated gilts. Overall, activity aimed to enhance portfolio efficiency through selective spread duration additions, capital structure optimisation, and opportunistic participation in new issues.

Sustainability

Engagement continues to be a priority for the team. This quarter, we made AI a focus point and an area where we intend to take more action going forward. We currently have two forms of engagement with respect to AI: participation in broader industry initiatives, and our own targeted focus on AI’s impact on company workforces. The broad industry initiatives we are involved in include the World Benchmarking Alliance (WBA) and the AI Company Data Initiative (AICDI).

We are members of the WBA’s Collective Impact Coalition on Ethical AI, which grew out of a UNESCO initiative published in 2022 aiming to define “Recommendations on the Ethics of AI”. The AI CIC publishes updated reports annually and uses a committee structure to engage with companies on their AI principles and implementation practices.

On the more focused side, we have drafted an email that we plan to use as the basis for individual company discussions. As part of our due diligence and ongoing engagement on strategic direction, we seek a deeper understanding of companies’ approaches to Artificial Intelligence. We aim to arrange calls to discuss current use of AI, practices, and future plans.

Outside of AI, we continue to respond to controversies as they arise. Bio-bead pollution along the south coast, linked to Southern Water – which we do not hold – prompted us in late December to ask each of our UK water holdings about exposure to plastic media in wastewater sites. The responses received so far have been very encouraging, indicating limited to no exposure and much stronger controls than those reportedly in place at Southern Water.

Outlook

We remain constructive on the outlook for corporate bonds going into 2026, with returns likely to be driven predominantly by carry rather than further material spread compression. We expect spreads to remain broadly range-bound, with larger spread moves not in our base case. With spreads already historically tight in many areas, we retain flexibility to add selectively should volatility create more attractive entry points.

Recent political events and shifting trade policies have contributed to increased market volatility. Despite this, we believe our high-quality corporate holdings remain fundamentally robust. If valuations become more attractive, we may selectively add credit exposure, while remaining prudent given the uncertain backdrop.

Fundamentals have weakened, mainly due to commodity sector pressures and cash erosion, but margins remain robust at near-decade highs, with defensive sectors showing resilience. Continued pressure on interest coverage is expected as refinancings continue and net interest costs increase. Around 30% of the investment-grade market’s debt matures by 2027, and refinancings will occur at higher rates. Net leverage has increased slightly but remains mid-range relative to the past decade.

It is becoming increasingly evident that outperformance will be driven by credit selection, an area where we have a strong track record. Our portfolio is tilted towards high-quality issuers offering relative value, with a notable overweight to financials – particularly banks and insurers – and resilient names in the telecoms sector.

We also see potential for capital gains should government bond yields fall and continue to maintain a long-duration stance. Combining current credit spreads with elevated gilt yields, all-in yields above 5% remain compelling; the Fund’s gross redemption yield currently stands at 5.12%, reflecting its high-quality investment-grade focus.

For 2026, we anticipate a low-growth environment. While inflation remains persistent and the “higher for longer” narrative prevails, we believe the UK economy may underperform market expectations. With signs of a softening labour market and weakening sentiment, we expect yields to end 2026 lower and foresee a longer-term decline in gilt yields as the UK’s economic vulnerabilities become more apparent.