Artemis Corporate Bond Fund update

The second quarter of 2023 was marked by heightened volatility, particularly in government bonds.

Investors faced a challenging environment as government bond yields surged globally, with gilts experiencing a noticeable sell-off.

The shift in market sentiment was driven by several factors, including renewed concerns around inflation, monetary policy tightening and improving economic prospects. It was only at the beginning of this year that economists were forecasting an economic downturn. And yet, economic data has continued to come in stronger than expected, putting into question the concept that an economic slowdown would lead to a lowering in inflation expectations and to interest rate cuts.

In this environment, the fund fell -2.83% while its benchmark, the iBoxx £ Collateralized & Corporate Index,

fell -3.43%. With gilt prices continually falling during the period, the fund’s mild short duration position was helpful.

Fund activity

The fund remained broadly 0.25yr short duration relative to the index. That is, the fund was less sensitive to changes in interest rates (bond prices move in inverse relation to interest-rate expectations) - having a lower duration is helpful when rate expectations move higher but hurts when they fall. However as gilt prices continued to fall, we started tempering the size of this position and ended the quarter with neutral duration relative to the index. The fund’s underweight duration continues to be taken via being short the longest-dated bonds. As the Bank of England starts to sell its gilt holdings and as gilt issuance looks to be materially higher going forward, long-dated gilts which have been a beneficiary of quantitative easing look vulnerable.

Credit spreads (the difference in yield between government and corporate bonds) were relatively stable over the period, as markets recovered from what had been a turbulent first quarter. We traded actively during the quarter, with most of our trades improving the credit quality of the bonds held. While corporate bonds remain resilient in the face of ever increasing interest rates, we are mindful that cyclical sectors would be more vulnerable to reduced consumption. In instances where these companies are trading near their most expensive levels, the risk/reward of owning them becomes less attractive.

It is worth highlighting that we did not hold Thames Water in the fund, even though it is one of the largest components in the index. Thames Water is the weakest name in the sector, as was well known and its valuations were already reflecting that.

Outlook

Investment-grade yields have readjusted meaningfully relative to other asset class yields. Yields look attractive and competitive compared to other income opportunities. In government bond markets, we see pockets of value emerging, by no means across the board, but our focus most recently has been on shorter-dated bonds. Government bond yields are once again attractive enough to act as a hedge in a 'risk-off' environment, and so we are cautious on taking a short duration position at this point as there is still a lot of uncertainty around the macroeconomic outlook. We started the year with the view that this would be a volatile year, as investors debated how quickly inflation would fall and how severe the economic slowdown would prove to be. We expect volatility will continue but with markets pricing in interest rates to hit >6.25% by the end of this year, we think a lot of bad news is already priced in. Corporate bonds are currently offering an attractive yield, so investors are getting well compensated to own a relatively defensive asset class, whose yield opportunity relative to other asset classes is more appealing than it has been in over a decade.