Artemis Global Income Fund update

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

The fund outperformed the market and its peers

US and global market indices both recorded new all-time highs during the quarter, with the MSCI AC World Index returning 9.2%, its strongest start to a year since 2019. 

The fund, meanwhile, returned 15.8%, significantly outperforming both the index and its peer group, where the average return was 6.2%. Strong returns from its holdings in financials and industrials were the main reason for this strong performance, more than offsetting the drag from its structural underweight to mega-cap beneficiaries of the AI boom, such as Nvidia and Microsoft.

Our investments in defence companies continue to deliver

Rheinmetall and Mitsubishi Heavy Industries gained 79% and 66% respectively over the quarter. In February, the German chancellor and Danish prime minister accompanied Rheinmetall’s chief executive to a foundation-laying ceremony for a new ammunition plant in Germany. After a long period of underinvestment in its military capacity, Rheinmetall’s CEO suggested that Europe will not be in a position to fully defend itself against an aggressor for another decade. The investment that will be needed to address this shortfall and restore badly depleted stockpiles of ammunition should provide structural support to Europe’s defence sector for years to come. Rheinmetall’s share price has increased by more than 300% since Russia invaded Ukraine.

A holding in building materials group CRH returned 27% on the quarter

It updated the market on its performance in 2023: its cashflows grew by more than 30% compared to the previous year and its margins expanded by 18%¹. Through a combination of dividends and share buybacks, it returned $4 billion to its shareholders last year. It did this while also continuing to pay down debt, with net debt-to-Ebitda falling to 0.9x by year end. CRH is just one of several companies in the portfolio benefitting from the boom in US manufacturing. In a presentation accompanying its results, the company pointed to “robust infrastructure activity underpinned by historic increase in government funding” and looked ahead to what it describes as “a golden age for construction”. Even after a strong recent run of performance (total returns of 122% in sterling terms over the last two years) its shares still trade at a discount to those of its smaller US competitors.

Financial stocks made a useful contribution to returns

Our European bank stocks have rallied strongly over the year to date. BBVA has perhaps been the standout performer. Its shares rose by more than 32% in the first quarter. Its net interest income increased again and the rapid growth of its business in Latin American continued. Although interest rates are likely to fall this year, a return to a zero interest-rate environment seems unlikely. And, for as long as interest rates remain positive, European banks should continue to generate excess capital to return to their shareholders through dividends and share buybacks.

The fund’s lack of exposure to mega-cap technology stocks remained a negative

In what was an overwhelmingly positive quarter, the fund’s lack of exposure to mega-cap technology stocks (and so to the excitement around AI) was the biggest negative for its relative performance. As a reminder, given their modest (or non-existent) dividends – and their elevated valuation multiples - most of these companies are not natural investments for a valuation-conscious fund designed to deliver income. Broadcom is one of few companies in this area that we do find attractive thanks to its dividend yield (although admittedly that has fallen from 3.7% at the beginning of 2023 to 1.6% today as its share price more than doubled).

Food producer Archer Daniels Midland came under pressure but we retain the holding

The main negative among the stocks the fund does hold was US food producer Archer Daniels Midland (ADM, down 12%). It delayed its earnings release due to a probe into accounting practices in its nutrition division. The shares fell sharply in response: at one point, it had lost a quarter of its market value. Towards the end of the quarter, however, the shares rallied sharply as the delayed earnings release revealed that the overstatement of profits had been relatively minor and did not pose any systemic threat to the business. News of a large share buyback and an 11% increase in its dividend per share were also welcomed. Admittedly, the significant fall in the price of corn since the middle of 2022 has been unhelpful for ADM. But, for a number of reasons – including climate change and increasing protectionism – we do not think this weakness is likely to last.

We added a number of new holdings in Japan

Our Japanese holdings now account for 19% of the fund. Our recent additions here tend to share a number of common characteristics:

• net cash balance sheets
• complex cross shareholdings
• trade below book value
• low returns on equity

These attributes make these companies ripe for corporate reform. More broadly, the pressure that the Japanese stock exchange is placing on listed companies to lift their price-to-book ratios above 1 and to increase their returns on equity could help unlock further upside in Japan. Nissan, a recent addition to the portfolio, currently trades on just 0.4x book value but is making headway in unwinding its complex cross shareholdings with Renault².

We also added two gold miners to the fund during the quarter

Gold prices have risen sharply this year to all-time highs³, but the share prices of gold miners Newmont and Kinross have lagged the gains in price of the commodity due to sharp cost inflation and a number of recent supply-chain issues. We believe these pressures are now easing.

We remain cautious on the immediate prospects for ‘classic’ income stocks

The fund’s allocation to its core bucket, which is home to ‘traditional’ income stocks (such as real estate, utilities and consumer staples stocks) remains close to its lowest level since the fund’s inception. That is because many of the companies in these sectors find themselves with capital structures that are poorly suited to a world of higher interest rates: they are simply carrying too much leverage. Our concern is that this may, in time, jeopardise their dividends. Our portfolio’s leverage (as measured by net-debt-to-Ebitda) sits at around 1x, close to a 10-year low.

Looking ahead, rates may need to stay ‘higher for longer’ than the market hopes

Hopes of a ‘soft landing’ in the US economy remain the dominant market narrative at present. Official data showed GDP growing at an annualised rate of 3.3% in the final quarter of 2023⁴. To this point, the US Federal Reserve is still suggesting that it will cut rates this year despite the strength of economy and the jobs market. The March CPI inflation reading must cast some doubt on that belief, however. Rather than falling, inflation actually rose (to 3.5%). Meanwhile, so-called ‘supercore’ inflation – one of the Fed’s preferred measures, which looks at services inflation excluding food, energy and housing – came in at an annualised rate of 8% over the last three months⁵.

We struggle to reconcile the strength of the US economy and these lingering inflationary pressures with the consensus belief that we are about to see material cuts in interest rates. In fact, the US economy may be at greater risk of overheating – especially keeping in mind the scale of the fiscal stimulus that has yet to be deployed across manufacturing – than falling into recession.

We continue to shun the ‘usual suspects’ held by many global funds

In our portfolio, our approach remains the same: we continue to look away from the ‘usual suspects’ and instead seek cashflows, dividends and dividend growth in unpopular areas of the global market that have attracted little investor attention in recent years. Japan and South Korea are two markets that embody some of the characteristics we are looking for. We find plenty of attractive investment ideas in both markets – and elsewhere.

As a result, our fund’s overlap with other global equity funds remains limited. When we compare our portfolio with those of the 15 largest funds in the IA Global Equity Income peer group, the average overlap is just 7%. Compared to the benchmark index, meanwhile, the portfolio trades on a c.50% discount on a price-to-earnings basis and generates double the roughly twice the dividend yield.