Artemis Monthly Distribution Fund update

The fund returned -0.4% over the quarter, in line with its peer group, the IA Mixed Investment 20-60% Shares Average.

Equities

The quarter was characterised by the continued dominance of the mega-cap US technology titans. The remarkable rally in the Nasdaq 100 continued, with the result that it returned 39% in US dollar terms in the first half of 2023 - its best start to a year for four decades. These gains were driven by excitement about artificial intelligence and underwritten by an injection of liquidity designed to ease the tensions in the US banking system.

US pharmaceutical company AbbVie was our largest single stock detractor. AbbVie's shares fell by almost 20% on the quarter. Sales growth from several of its newer therapies came in slightly below expectations and investor concerns around the pricing controls imposed by the Inflation Reduction Act compounded the weakness.

We have been surprised by how weak the healthcare sector has been, given its attractive defensive characteristics and historic outperformance going into recessionary environments. We have, however, reduced the portfolio’s exposure to healthcare due to our concerns around the implications of the Inflation Reduction Act. For now, there are better homes for our clients’ capital in other regions and sectors.

Defence companies BAE Systems and Rheinmetall also underperformed

The catalyst seemed to be optimism around Ukraine’s counter-offensive spurred by the chaotic events unfolding in Russia. Even if there is a speedy resolution to the conflict, we believe both companies are well placed to deliver significant growth in their cashflows and dividends over the medium-to-long term. There has been a structural shift in global defence policy and in spending commitments.

Our holdings in financials fared better in the second quarter

Several of these companies, particularly banks, released strong results, underscoring the power of higher interest rates to boost their earnings. Many banks have a multi-year, double-digit return profile thanks to a combination of dividends and share buybacks. We believe this is an attractive prospect, particularly in today’s uncertain environment.

Bonds

We increased the fund's allocation towards government and investment-grade corporate bonds. We believe these areas hold increasingly attractive opportunities for the fund given their ability to provide some insulation and diversification to the equities and high-yield corporate credit held in the wider portfolio.

The bonds we bought on the government bond side were predominantly inflation-linked securities (largely US TIPS). We think these securities to offer an attractive combination of a high 'real' yield alongside an attractive inflation hedge.

One of the areas on the corporate bond side that we added exposure to over the quarter was senior US bank debt. We could buy bonds in major US banks (JPMorgan and Bank of America) at very attractive spreads and yields following the problems in the US banking sector. We believe some investors worried about the banking sector more broadly but we instead saw these major players as beneficiaries of a 'flight to safety' from smaller regional banks.

Outlook

The overarching theme of the first half of 2023 has been the creeping fear that whilst 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 interest rates at the front-end of global bond markets. 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.

As a result, 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 bonds we are trying hardest to avoid are businesses with very high levels of debt that will struggle with the combined impact of higher funding costs and lower demand.