Artemis Monthly Distribution Fund update

Source for all information: Artemis as at 31 December 2023, unless otherwise stated.

The fund returned 5.7% over the quarter, in line with its peer group the IA Mixed Investment 20-60% Shares Average.

Equities

The defining event of the fourth quarter was the market’s embrace of a comforting fairytale: Goldilocks. Investors seized upon below-expected inflation readings and dovish signals from the Fed as evidence that the US central bank would cut interest rates aggressively in 2024 - and by more than implied its own ‘dot plot’. By the end of 2023, markets were pricing in six cuts to interest rates in 2024 while simultaneously holding out hopes there would be a soft landing in the US economy.

In time, this ‘Goldilocks’ scenario, in which economic growth is ‘just right’ (hot enough to avoid recession but not hot enough to fuel inflation) may prove to be wishful thinking. But, towards the end of last year, it was a story many investors were eager to believe – and sufficiently convincing to trigger a strong rally.

The gains for global equity indices over the quarter were led by the so-called ‘Magnificent Seven’ US technology stocks (over 2023 as a whole, these stocks collectively added an astonishing $5.2 trillion in market cap). In tandem, hopes that rate cuts would reduce funding costs for leveraged companies saw a rebound in some of those areas that had come under the greatest pressure during the summer, such as real estate. At the other end of the performance spectrum, energy stocks fell. By the end of 2023, oil prices had fallen by almost a quarter from their late-September peak despite the threat of regional escalation in the Middle East and its potential effect on energy supplies.

Among our holdings, the best contribution came from Broadcom, which rallied strongly in reaction to robust fourth-quarter results and guidance that suggested its AI-related earnings could double to $8 billion in 2024. With a 2% dividend yield, it is one of few technology companies that we find attractive. Rheinmetall and BAE Systems also contributed well over the quarter. In part, this was a response to the terrible violence engulfing the Middle East. Meanwhile, the war in Ukraine continues to grind on. Governments worldwide are starting to address significant shortfalls in defence spending. This results in improved pricing power for defence companies and reduced uncertainty around their future earnings.

Elsewhere, CRH delivered total returns of 25% (sterling) to its shareholders last year. And while its recent share-price performance has been strong, cash returns have – through a combination of dividends and share buybacks – been attractive for a number of years. The company bought back some $3 billion of stock last year; another $300 million is due to be retired by the end of February.

On the negative side, energy was the market’s weakest performer over the quarter, with the MSCI AC World Energy index down 4%. In part, that was a reaction to the oil price falling by almost a quarter from its late September peak. The other factor was that energy stocks are regarded as short-duration assets and are therefore among the areas of the market that benefitted least from hopes of lower rates. Exxon was the single biggest detractor, falling by 18% in sterling terms.

Bonds

As markets priced in easing conditions, government bond yields fell across the board. The US 10-year Treasury yield fell from 4.57% at the end of Q3 to 3.87% at the end of Q4. The UK 10-year gilt yield fell from 4.44% to 3.54%, while the German 10-year Bund yield ended the quarter 0.81% lower at 2.03%. Credit spreads also compressed. High-yield markets outperformed investment grade in both the US and Europe. Meanwhile, quarterly returns in US and European investment grade credit markets have not been better since Q3 2009. The rally was broad-based across all sectors, with securitised credit, covered bonds, and quasi-government bonds all performing strongly over the quarter.

For our fund, inflation-linked US Treasuries were top contributors as the market moved quickly to price in the interest rate cuts. There were also strong contributions from shorter-dated high yield, particularly in the higher quality BB and B-rated bonds. The general outperformance of high yield also benefited the fund.

Activity

In equities, as part of our efforts to hedge the portfolio against falling interest rates, we added AGNC, a mortgage REIT. At the end of December, its shares yielded 15%, a level of payout we believe is sustainable in a world in which US interest rates have peaked.

We added a new holding in Verizon. After performing poorly for much of 2023 due to its high debt levels, we think some value has begun to emerge in the telecoms sector. Verizon trades on 8x earnings and offers a double-digit free cashflow yield. Unusually, with a dividend yield of 7% Verizon’s shares currently yield more than its bonds.

We also bought BlackRock. As the world’s largest fixed-income manager, it is a clear beneficiary of the rally in the bond market. It also gives the portfolio some upside exposure should the remarkable run by the Magnificent Seven continue (they increasingly dominate returns from its index funds) while paying us a c.3% dividend yield.

In the bonds component of the portfolio, we slightly increased duration, given the likelihood that we have reached peak interest rates. We prefer to increase duration through government bonds as we are seeing attractive yields from shorter-dated high yield. We remain happy with the position in TIPS (inflation linked Treasuries), given undemanding inflation premiums. The real yields we are able to get for relatively low risk are undemanding.

Outlook

Though the outlook remains unpredictable and unclear, we are likely to have reached peak interest rates and the end of the hiking cycle. We can then turn to when interest rates might begin to fall. Bond yields are likely to compress over 2024 and there is therefore the potential for some compelling capital appreciation across the portfolio. Generally speaking, income assets have re-priced considerably over the last two years, and valuations remain attractive. in the post financial crisis era, bonds were used for return and equities for income. However, this has now ‘inverted’ and bonds are well and truly back as a source of attractive income for investors. All in all, therefore, we see the potential for the portfolio to generate