Artemis High Income Fund update

Source for all information: Artemis as at 30 September 2024, unless otherwise stated.

Performance

Over a choppy quarter for financial markets, the fund generated a total return of 4.1%, outperforming its peer group, the IA’s £ Strategic Bond sector, where the average return was 3.7%. That strong performance capped off a good start to 2024: over the year to date it has produced a total return of 9.5% versus an average return of 5.0% from its peers.   

As the table shows, the fund’s commitment to delivering a high level of income has resulted in a significant margin of outperformance relative to its peers over the long term. Thanks to the rise in yields seen over the past two-and-a-half years, we believe focusing on income will continue to pay dividends going forward. 

The chart below shows the performance of the fund against UK gilts (as measured by FTSE Actuaries UK Conventional Gilts All Stocks Index) over the past 12 months. Clearly, the return of 7.9% from gilts has been a respectable outcome. Equally, however, the 16.4% return from our strategy shows the additional return that can be delivered by being slightly more adventurous in your fixed-income allocation.  

Returns from gilts have been lacklustre since the turn of the year 

The other thing the chart shows is how consistent returns from our strategy have been. The UK government bond market delivered a healthy slug of returns in the last few months of 2023, when investors began to anticipate rate cuts. Since the new year, however, gilts have fallen slightly (by 0.2%) – while our strategy has returned 9.5%. That reflects the regular stream of income that our high-yield bonds have delivered along with strong stock selection.

Our interpretation is that our strategy could potentially work well alongside an allocation to government bonds, simultaneously diversifying and improving returns.

Contributors and detractors

Some of the key drivers to the fund’s returns over the quarter included useful contributions from the equity portion of the portfolio, which accounts for 15% of the fund. These included:

• Tesco;
• Barclays;
• NatWest; and
• National Grid.

On the credit side, meanwhile, some of the biggest contributions came from the European real estate sector, where we saw rebound in property prices and a rise in rents. As such, we saw healthy returns from our holdings in bonds from:

• Heimstaden (Swedish residential landlord); and
• CPI Property (Czech landlord).

Elsewhere, bonds issued by Sotheby's, the global auction house, responded well after it announced a combined $1 billion equity injection from its existing owner, Patrick Drahi and Abu Dhabi-based sovereign wealth fund ADQ. Most of the funds will be used to repay debt.

Inevitably, not every holding outperformed over the quarter. On the negative side, underperformers included:

• Southern Water, (bonds);
• Melrose, aerospace (equities);
• Isabel Marant, French luxury goods (bonds); and
• BMW, the carmaker (equities).

Activity

James Hardie (bonds, new holding) – We bought high-yield bonds from this building materials company. This business appears to combine a strong market position with low leverage and strong cashflows. It has a market capitalisation of $16.4 billion while its net debt is $800 million. Effectively, the company's market value would need to fall by 95% to burn through the equity cushion. Over the past decade, the company has generated $2.3 billion of free cashflows and grown its top line by 140%. Frankly, this shouldn't be a 'high yield' company. But we still get paid high-yield levels of income. This seems a like a good deal to us.

IHO Verwaltungs (bonds, new holding) – We added a new holding in this family-owned holding company for German auto parts/tyre manufacturers Schaeffler, Continental and Vitesco. We believe these bonds are comfortably covered by the large equity holdings in these three companies. The bonds we bought mature in 2028 with a very healthy yield of almost 9% in sterling terms.

Melrose (equities, addition) – We added to the fund's existing holding in aerospace group Melrose after its shares fell in response to a 'bear attack' from a hedge fund based on what we view as an overly cynical interpretation of its accounting practices.

InPost (bonds, new holding) – You may have seen parcel-collection machines ('lockers') belonging to this Dutch delivery business in your local supermarket or retail park. We bought bonds that are due to mature in July 2027 and which, at the time purchase, offered a healthy-if-unspectacular yield to maturity of 5.6%. Our belief, however, is that there is a good chance that InPost will, like many high-yield issuers, opt to refinance its bonds at least a year early. Under this assumption, a 5.6% yield to maturity moves up to 6.5%. This is not a guarantee, but even if InPost chooses not to redeem this bond early, we would still receive almost 1.5x the return on a gilt of a similar maturity. So, this seems like a good deal to us.

Ocado (bonds, sale) – While we still believe in Ocado’s mission to become a high-margin, high-cashflow technology services company, this was increasingly reflected in the price of its bonds. We sold our position following a successful refinancing operation.

Victoria Carpets (bonds, sale) – Rumours that this UK flooring company was considering a potentially disruptive fundraising prompted us to sell its bonds. While our bonds were relatively insulated from the potential negative implications of this fundraising, this action fundamentally changed our view of the company’s value and options.

Outlook

Towards the end of the summer, growing optimism that interest rates - particularly in the US - were likely to fall boosted returns from both government bonds (falling rates should bring bond yields down, driving prices up) and equities (lower yields drive investors' 'animal spirits' and fuel their appetite for risk). These returns did not reflect any fundamental change in the expectations of investors around the cashflow profile of these investments; lower interest rates simply drove up valuations.

Today, credit spreads are reasonably tight and, while we are reasonably comfortable that they are unlikely to widen significantly in the near future, there is not a huge amount of room for them to narrow much further. We are therefore looking for idiosyncratic opportunities to enhance returns on an individual company level while broadly staying in shorter-dated bonds of companies that we believe would be able to make their way through a meaningful recession without impairment (while also paying us attractive levels of income). 

Our focus on generating a high current level of income (with some long-term growth through our small allocation to dividend-growing equities) is one that we feel can add diversification to many portfolios in the current environment. Our portfolio has a low duration (it is relatively less sensitive to changes in government bond yields) so it did not benefit from the significant rally in US government bonds in the way that many of its peers did. But that it nevertheless managed to keep up with its peers over the summer shows that diversification need not come at the expense of returns.

Returns from this fund will be correlated to changes in risk appetite and movements in bond markets. Equally, however, we believe that our focus on income means this fund's primary driver of returns differs from many of the funds in its peer group, which tend to carry significantly more duration risk. In a world where global equities and bonds rose in unison as expectations for rate cuts were brought forward, it is not impossible that they will fall in unison too – and, under those conditions, a fund like ours can provide useful diversification to investors.