Artemis Corporate Bond Fund update

Volatility in bond markets

The third quarter of 2023 followed on where the second quarter left off, with high volatility in corporate bonds, driven by moves in underlying gilts. Investment-grade spreads finished the period around 15 bps tighter than at the start.

The main factor behind these gilt price gyrations seems to be general market uncertainty. Economic data remains robust, the labour market is tight and inflation appears to be falling. Meanwhile, central banks have hiked rates faster than at any point in living memory and drummed in the messaging that rates will stay here for a while longer. Yields are near the highs of the Global Financial Crisis, but the economy does not yet appear to be slowing. The path forward for markets is understandably a little unclear.

Despite this volatility, the fund returned 2.3% over the quarter, in line with the iBoxx £ Collateralized & Corporate Index's return. We took advantage of market dislocations to make relative value and duration trades, ultimately profiting from the volatility over the quarter.

Closing out the short duration position

Government bond yields had a roller coaster ride over the quarter. Gilts outperformed US Treasuries and German bunds. The main sell-off happened in September, when the 10-year US Treasury moved from 4.0% to 4.6%, while 10-year German Bund yields sold off from 2.4% to 2.8%. 10-year gilts were volatile throughout the quarter, oscillating down to 4.2%, up to 4.7%, before finishing September flat on Q3 at 4.4%. The fund's short duration position coming into September served us well, with the move back to neutral capturing the gilt recovery at the end of the month.

Buying higher-quality new issues

Fund activity was varied over the quarter. As is usually the case, the summer months were relatively quiet, with a lack of new issuance driving credit spreads tighter. This then partially reversed as the summer came to an end and primary markets opened up again with new issues trading at attractive premiums. We took advantage of the strength in the market to switch into higher-quality credits. We also raised cash for the new issues which came in September. As noted above, the fund made a positive return over the quarter. In particular our holding in Aviva legacy bonds performed well following a tender, and the fund not owning any Thames Water (despite being one of the index’s largest constituents) was also additive.

Outlook – Corporate bond yields at attractive levels…

“As is often the case, we are navigating by the stars under cloudy skies” was Federal Reserve Chair Jerome Powell’s assessment of the market outlook. Continuing inflationary concerns and mixed economic data suggest central bankers’ work is not yet done. Combine this with further gilt issuance and the road ahead for government bonds looks a little uncertain. We think long-dated gilts look particularly vulnerable.

Credit spreads have performed well. Given that the economy has proven far more resilient than once feared, this feels justified. However, the further central banks raise interest rates and hold them there, the more likely the economic cracks of earlier this year reappear elsewhere.

Investment-grade yields have readjusted meaningfully relative to other asset class yields. They now look attractive and competitive compared to other income opportunities. In government bond markets, we see pockets of value emerging, particularly in shorter-dated bonds. Government bond yields are once again attractive enough to act as a hedge and so we are cautious on taking a short duration here as there is still a lot of uncertainty around the macroeconomic backdrop.

With corporate bond yields still at high levels, we believe 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.