Artemis Strategic Assets Fund update

New approach for the fund

The new investment team, led by David Hollis, took over the fund on 6 June 2023 and began transitioning the portfolio to the new approach.

The team will take a shorter-term outlook, quickly harvesting profits and exiting loss-making positions. The aim is to deliver more stable returns and minimise drawdowns. The new approach combines quantitative macroeconomic inputs, the team’s experience and judgement, with market technicals, to build conviction in investment opportunities across asset classes.

The fund delivered a return of 0.7% during the quarter, ahead of the peer group's return of 0.4% but behind the target (CPI +3%) of 2.4%.

Market backdrop

Equities and corporate bonds were generally strong during the quarter. Investors focused on the more positive narrative – the resolution of the debt ceiling, strong US labour market, healthy consumer balance sheets, housing market rebound, peak Fed/inflation and AI secular growth. For the time, this dominated the more bearish narrative of central banks keeping interest rates higher for longer, margin risks, dampened sentiment and weak China recovery.

The Bank of England surprised markets by hiking by an unexpectedly large 50bps in June. Over the quarter, the 10-year gilt yield rose by 90bps, with the market effectively suggesting that the UK has an idiosyncratic persistent inflation issue. The ECB also hiked and signalled more to come, despite weak economic data. Australia and Canada’s central banks resumed rate increases after a pause, while the Federal Reserve chose not to raise rates despite increasing their inflation forecasts.

Performance

In Q2 the returned +0.7%, ahead of the peer group's return of 0.4% but behind the target (CPI +3%) of 2.4%. Year to date the fund has returned +4.5%, in line with the target and well ahead of the peer group return of 2.3%.
Our equity allocation made a positive contribution of 0.6%. The fund was overweight 'tech staples' and the Nasdaq with Alphabet and Meta being the largest positive contributors in the period. Our bearish equity positions worked well at the end of the period. The short in emerging markets was a key contributor, as were our European sector trades (telecoms and resources). These were partially offset by a long European vs. US equity position.

In fixed income, our positions had mixed performance. Our short in peripheral European bonds worked well as we were able to take advantage of overbought conditions. Conversely, we were stopped out of a long position in Canadian bonds after stronger-than-expected economic data caused yields to rise.

Portfolio activity

In early June we started the transition from individual equity and fixed income securities to highly liquid asset class indices and derivatives to give investors exposure to a broad range of asset classes. A number of new positions were initiated to reflect the output of our analysis.

• Short emerging markets equity. Whilst EM stocks were initially strong in the first part of the month on rumours China would support growth by providing stimulus, in the event the Chinese central bank cut rates by less than expected. Our model displayed a clear sell signal. This, coupled with Fed Chair Powell’s hawkish rhetoric on US rates provided us with a strong setup to short these equities. We took profits later in the month as our model moved to neutral. We will look to re-establish this position as the situation evolves.

• Short peripheral European bonds. Spanish bonds outperformed German bunds given a relatively benign risk backdrop early in the month. We seized the reversal of this trend as a reason to establish a relative short in Spanish against German bonds. As of the end of June this trade was still open.

• European yield curve flattener. The European economy generally lags the US and we believe this will certainly be the case in the current cycle. We are therefore likely to see a flattening in yield curves in Europe due to a longer period of rate hikes by the ECB. To profit from this, we established a yield curve flattener position by selling shorter-dated bonds, and buying longer-dated bonds in anticipation that the curve would continue flattening in mid-June. We booked profits in this trade near the end of the month after some weaker data emerged.

Outlook

While the Federal Reserve continues hiking rates history tells us that stock markets will generally move sideways. This would have been the case in the first half of the year, had it not been for a select few stocks in the Nasdaq which have powered the S&P500 index higher. For now, this outperformance of technology stocks relative to the broader US equity market appears to have stalled. This makes it more likely that we will see some downward pressure on US stocks in the coming quarter, which is what our models are generally indicating.
Within bond markets, we are reaching levels of yield curve inversion that we haven’t seen before when comparing the yield on 10-year bonds to that of 2-year bonds in the US. Should US data begin to roll over we expect yield curves, led by the US, to steepen (that is shorter-dated bonds will outperform longer-dated bonds) although while the ECB and Federal Reserve deliver hawkish rhetoric this maybe later than expected.
The effect of rising interest rates typically has a 12-to-18-month lag on the economy, which is likely why US economic data has been so robust up until now. Should this start to deteriorate, we expected credit spreads (the difference in yield between government and corporate bonds) to begin widening and equity markets to accelerate their decline as we move into a recession.

The chances of the US economy avoiding a recession remain relatively slim in our opinion given the magnitude of monetary tightening we’ve seen from developed market central banks and the speed with which interest rates have been raised. Most financial markets and macro indicators are following a relatively typical path that we’ve seen in the run up to prior recessions.