Artemis Funds (Lux) – Global High Yield Bond update

The fund returned 1.3% over the quarter, slightly behind its benchmark, the ICE BofA Merrill Lynch Global High Yield Constrained USD Hedged Index, which returned 1.6%.

We added a number of new names during the quarter. We bought AroundTown, a German property company. Property stocks have been badly hit by the changing interest rate environment over the last 18 months, and AroundTown (which is still rated BBB+ at S&P) had been significantly affected by the sell-off. The company is well diversified, with 43% of its exposure offices, 32% residential, and 18% hotels. We also bought bonds in Allwyn, which has recently won the contract to operate the UK National Lottery. The company already manages lotteries globally and we believe has a very good market position – built on a strong operational track record and trusted status with regulators – that provides a strong fundamental support for our investment.

Another company we took exposure to over the quarter was LKQ. Again, this is a company we know well and have lent to in the past. The core of the business – working with auto repair shops globally, and both providing and sourcing replacement auto parts through them – is a business we have observed to have little cyclicality, be very profitable, and where there is a clear benefit to being a market leader.

We added Merlin, the global operator of the Legoland theme parks, along with Madame Tussauds and Alton Towers. This is a business we have followed for a number of years, having initially taken exposure to it back when it went private in 2019. We sold it in late 2021 as we no longer saw valuations as compelling. A new issue from the company gave us an attractive opportunity to lend to the company again. We like the company’s excellent brand position, strong management, and solid cash generation.

Later in the period we added some core, BB high-yield names that we believe to be very fundamentally strong and pay us attractive yields. These included Fortrea (medical trial management), Masonite (US door producer); Ardagh Metal (global can producer); and Levi Strauss (apparel producer). We also bought some investment-grade-rated bonds trading at similar valuations to BBs. We bought positions in Inchcape (car distributor), Weir Group (engineering solutions), and Close Brothers (UK financial services). The final category of additions were three subordinated financial bonds – issued by Legal & General, Barclays and UBS. These all looked attractive to us on a yield to perpetuity basis versus the wider high-yield market, and had significantly lagged the wider post-Credit Suisse rally in subordinated financials, providing us with an attractive opportunity to add.

We also made a switch in the consumer apparel side of the portfolio. We sold our position in Wolverine Worldwide, a company that operates a number of footwear brands (including Merrell and Wolverine) as well as Sweaty Betty, the lifestyle apparel brand. Against this we bought a position in Crocs, the producer of divisive rubber footwear. We believe the market to incorrectly assess Crocs as simply being a Covid beneficiary and not having developed an enduring enough market position – rather, we believe Crocs has actually created a brand new segment within the market and is in fact seeing that segment solidify and grow post-Covid rather than fade. We also have a strong belief that more broadly high yield investors fail to adequately appreciate the value of strong brand equity, and Crocs definitely appears to us to fit into this mould.

We sold our position in BMC, the global server software provider, as we believed that our optimism around the business’ fundamentals were better reflected in valuations. We also sold our position in Jerrold (the UK alternative lender), as it had rallied significantly from the lows last year, we had some concerns about potential over-extension in their credit lending, and the name is too closely correlated with some of the subordinated financials additions we made over the month. In addition to these two complete sales, we trimmed some of our larger positions. We did this in order to retain flexibility – while we are broadly reasonably constructive on the high yield market and current valuations, we wanted to ensure we had room to add exposure should volatility present opportunities.

Outlook

The overarching theme of the first half of 2023 has been the creeping fear that while inflation is certainly rolling over, there is increasing uncertainty as to where it rests. Central banks may have to tighten policy more than previously expected to reduce inflation and this has had a significant impact on short-dated bonds. Accordingly, any notions of cuts have been priced out of the market for the end of the year and the conversation has changed from when cuts start after this pause, to whether there will be the need for further hikes after the pause. This change in dynamic is important because it ultimately is likely to influence the extent of economic damage that occurs and by extension what the default picture for high yield looks like over the coming years.

We have broadly leant into our approach in two key ways: we have added higher-quality exposure where we believe we were being well compensated for it, and we have reduced lower-quality exposure where we believe volatility will be felt should recession fears increase further. Broadly, the names we are trying hardest to avoid are over-levered businesses who will struggle with the combined impact of higher funding costs and lower demand. However, investors should take comfort from the strategy’s tiny exposure to CCCs and our disciplined approach to managing volatility. Notwithstanding this, we still retain exposure to cyclical businesses and believe there are outstanding risk/reward opportunities in the current environment.