Artemis High Income Fund update

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

• The Artemis High Income Fund delivered a total return of 3.5% over the quarter, versus 0.9% from its peer group.
• Holdings in high-yield bonds in the property sector and in the shares of UK banks were useful sources of returns.
• The strength of the global economy is offering powerful support to high-yield bonds and dividend-paying equities.

Performance: first quartile over all major time periods

Our strategy of investing in income-producing assets with a relatively low sensitivity to changes in interest rates continues to serve the fund well. It delivered a return of 3.5% over the quarter, versus an average return of 0.9% from its peer group, the IA’s Strategic Bond sector.

As the table shows, it is in the top quartile of its peer group over one, three five and 10 years to the end of the quarter, demonstrating the compelling total returns that can be generated through a consistent focus on delivering income.

Review: avoiding bond market blow-ups and profiting from a rally in UK banks

The primary driver of the fund’s outperformance this quarter was the strength of the high-yield bond market and our successful avoidance of some of the painful blow-ups that hurt a number of our peers. These included:

• Altice France (the French telecoms company);
• Ardagh (the global packaging company); and
• Intrum (a European debt consolidator).

We have been warning for some time that bond issuers with over-levered capital structures – particularly in the telecoms sector – were at risk of running aground once the reality of higher interest rates hit. We think these blow-ups are just the thin end of the wedge. So, while we remain enthusiastic about high-yield bonds, careful credit selection is required.

Among the bonds the fund does own, we saw very strong performance from our holdings in the property sector. These included CPI and Heimstaden. Investors began to warm to the sector as the prospect of interest rates having peaked met with depressed valuation levels.

Elsewhere, UK high-yield names – which we view as structurally underappreciated by the US dollar and euro-dominated global high-yield market – began to attract support. Our holdings in homebuilder Miller Homes, Victoria (flooring), True Potential (wealth management), and RAC (auto recovery) moved higher. We continue to see value here, notably in the homebuilding sector, where we have added to our positions. Elsewhere, our holdings in US homewares retailer At Home and German engineered-wood manufacturer Pfleiderer performed well as the market look again at some of last year’s oversold names.

On the equity side, UK banks NatWest and Barclays both made useful contributions to returns over the quarter. Their net interest margins disappointed last year but this is starting to change. Better-than-expected results are helping to convince investors that last year’s earnings downgrades are a thing of the past.

Elsewhere, housebuilder Vistry (up 34%) indicated that it has seen a material increase in reservations across its business. It also announced further success for its partnerships business, where it collaborates with housing associations and public bodies to build affordable homes in mixed-tenure developments. It was named as the preferred bidder on a £276 million scheme for 739 new homes in Barnet.

Activity: finding value in ‘refi’ trades

After a quiet start to the year, the new issue market for high-yield bonds reopened in March. We participated in a selection of deals where we saw a combination of solid fundamentals and attractive pricing. These included:

• New Home, a US homebuilder;
• Medline, a US-headquartered healthcare products and distribution business; and
• Miter Brands, a US window manufacturer.

Two of these deals, from New Home and Medline, were used to refinance existing debt (Miter Brands used its issue to fund its purchase of PGTI, a competitor). We think some of the most interesting opportunities in the high-yield market are these so-called ‘refi’ trades. These are where companies elect to refinance bonds that the market had expected to remain outstanding for a while and, in the process, provide a nice capital gain to bondholders.

Another example of this during the quarter was CBR, a German ladies’ fashion wholesaler. Its bonds were trading at a price of 94 at the beginning of November last year. That represented a yield-to-worst of just over 8% to the bond’s expected maturity in April 2026. That’s an attractive yield but it isn’t exceptional. CBR, however, has chosen to redeem those bonds at a price of 101.375. The result is that, rather than delivering a rate of return of just over 8%, the bonds have actually delivered an annualised internal rate of return of 28% since the start of November.

Similar ‘refis’ are happening elsewhere, and we have actively been setting up the portfolio to take advantage of these opportunities. So, in the secondary market we added positions in Albertsons (the US grocery chain) and Iron Mountain (the global data storage business). We think these could prove to be similar opportunities.

On the sell side, we sold our position in Aroundtown’s hybrid bonds following their strong rally. We also sold our holding in LKQ (a US auto repair/parts distribution business) following significant spread tightening.

Outlook: Strong economic growth continues to support equities and high-yield bonds

In our view, bond markets continue to be attractively priced, with yields that compare favourably with those seen over the last 15 years. The resilience of the global economy in the face of higher interest rates does mean that a strong rally in government bonds looks unlikely in the short term. But it should support demand for risk assets such as high-yield bonds and equities. The beauty of today’s market conditions is that, in contrast to the long period when quantitative easing held rates down, we can harvest attractive levels of ongoing yield from high-yield bonds and use them to generate an attractive total return.

At the same time, a number of high-yield bonds from issuers with over-levered capital structures are having their viability re-examined in the face of persistently high funding costs. From the perspective of high-conviction active managers using detailed credit analysis to deliver total returns through investing in high-yield bonds, it is hard to imagine a better backdrop.