Artemis Funds (Lux) – Short-Dated Global High Yield Bond update

Source for all information: Artemis as at 31 March 2024, unless otherwise stated.

The Artemis Funds (Lux) – Short-Dated Global High Yield Bond Fund made 3% in the three months to the end of March, compared with 1.3% from its Sterling Overnight Index Average (SONIA) benchmark.

Although the market has tightened from the wide levels we saw in October 2023, we are still at the upper end of the yield range in the post-Global Financial Crisis period. From these kinds of levels, average historic one-year returns have been in the mid/high single digits.

However, the market is currently in an unprecedented situation. Outside the Global Financial Crisis and the bursting of the dotcom bubble, cash prices of bonds are at all-time lows.

Because of the intricacies of the high-yield market and callable bonds, these low cash prices provide a potential boost to the likely return. It also means investors can reasonably expect a better outcome than what is being reflected in the yield-to-worst figures.

The chart below demonstrates the current spread-to-worst percentiles versus history, then the percentiles adjusting for the fact that high-yield bonds tend to get called a year in advance – particularly in bonds with less than five years until maturity, where this fund concentrates, and European high yield, where we have a sizeable exposure.

Spread to worst and to call 1yr ahead of maturity percentiles

Positives

Heimstaden, Miller Homes and Catalent made the biggest contribution to returns during the quarter.

Swedish residential landlord Heimstaden has been one of the worst performers in our portfolio over the past year, having been caught up in the European property sector’s woes. While contagion was somewhat inevitable as a painful valuation readjustment process took place and rent increases took time to phase in, we remain confident in the attractiveness of fully occupied residential property in the Nordics compared with office and retail, even after the recent rebound.

We wrote a note last August highlighting the value in Miller Homes. Our view was that market sentiment on UK assets in general, and the housing sector in particular, was overly negative. In Miller, we were attracted to its customer segment, strong asset backing, flexible cost structure and experienced management team. It did well after M&A activity in the sector highlighted just how well covered its bonds were.

We lengthened our exposure in global drug-delivery device manufacturer Catalent in the third quarter of last year, rolling over from its higher cash-price 2027 US dollar notes into its euro-denominated 2028 bonds. Our rationale was that this would provide an enhanced yield and increased upside in a company we thought had turned a corner following Covid-related disruptions. In February, Novo Nordisk announced plans to take Catalent over.

Negatives

We suffered from our positions in Isabel Marant, ams Osram and Close Brothers during the quarter.

French luxury clothing brand Isabel Marant has suffered as retailers have cut orders and inventory after a Covid-driven overstocking. The company adjusted its strategy towards ‘premiumisation’, which has reduced volume in the short term but will drive margin and brand equity in the long run. We remain confident in management and supportive of the strategy.

Electric light and sensor manufacturer ams Osram was one of our best performers last year, making 19.9%. However, it fell during the quarter after announcing one of its cornerstone contracts supporting its investment in MicroLED production had unexpectedly pulled out.

Financial services provider Close Brothers cancelled its dividend after warning of "significant uncertainty" over the outcome of the Financial Conduct Authority’s review of motor finance commission arrangements. Its shares and bonds sold off as a result, and we sold out.

Activity

We participated in a deal for US homebuilder The New Home Company. This deal was used for a ‘refi’ trade – bonds that the market is pricing to remain outstanding for a while, but that companies are more likely to refinance sooner rather than later (and in the process potentially provide a capital gain to investors).

Another example of this was our holding in CBR Fashion – the German ladies fashion wholesaler had bonds trading at a price of 94c at the beginning of November last year. That was a yield to worst (the convention in the market) of just over 8% to the bond’s maturity in April 2026. An attractive yield, but hardly a table thumper.

However, the bonds were being redeemed at a price of 101.375c, and repaid with the proceeds of a bond that the company was going to have to pay an interest rate of almost 1 percentage point more in.

The end result was that rather than delivering a rate of return of just over 8%, from the start of November the bonds delivered an annualised internal rate of return of 28%. This is happening across the market, and we have actively been setting up the portfolio to take advantage of these opportunities. In the secondary market, for example, we added positions in Albertsons (the US grocery chain) and Iron Mountain (the global data storage business).

On the sales side of the equation, we exited holdings in bonds secured on oil & gas assets in Israeli waters. Prices have recovered since Hamas’s attack in October, but the higher risk profile makes it difficult to justify exposure on an ongoing basis.

A strong rally led us to sell our holding in auto parts supplier Grupo Antolin. We sold out of CVR Energy on news it could be merged into Icahn's direct ownership group, which we would regard as a credit negative.

Outlook

Bond markets remain attractively priced, with yields that compare favourably with the post-Global Financial Crisis period. The resilience of the global economy in the face of higher interest rates should support risk markets, although it does mean that an immediate rally in government bonds seems unlikely. The beauty of these markets though is that unlike the quantitative-easing era (and unlike some of our peers who seem to long for a return to this environment), we can now rely on high levels of ongoing yield to provide total return. We also have the benefit of occasional early-redemption capital appreciation ‘pops’.

Elsewhere in the market, there are many over-levered, over-owned capital structures whose viability is being re-examined in the face of high funding costs.

We believe this plays into the hands of a high-conviction, index-agnostic, actively managed strategy focused on the global high-yield market.