Artemis Monthly Distribution Fund update

Source for all information: Artemis as at 31 March 2025, unless otherwise stated.

Overview

After turbo charging global equities in late 2024 and early 2025, US exceptionalism has more recently encountered some potential challenges. The advent of DeepSeek – a Chinese competitor to ChatGPT that was allegedly developed at a lower cost and capex intensity – questioned the long-held view that American companies reign supreme in technology and AI.

Latterly, talk of tariffs on some of the US's largest trading partners resulted in soft economic data deteriorating. This initially led to government bond yields falling on a flight to the safety of fixed income. However, yields began to climb again after the end of the period and the uncertainty created by the 'Liberation Day' announcements, while the gold price rose 15% (its largest quarterly gain in 40 years). 

The S&P 500 posted its worst quarter since mid-2022. Technology companies, which have been so dominant in global equity markets for more than a decade, de-rated sharply, with the S&P 500 Info Tech index falling more than 15% in Q1. 

High-yield spreads moved higher from near record levels of tightness. Despite this risk-off move, we believe the technicals of the high-yield market remain relatively robust, primarily as a result of demand for US high-yield bonds (the US makes up about 80% of the high-yield market) structurally outstripping supply for many years.

Meanwhile, Europe saw the most significant quarterly outperformance of the US for a decade. Aerospace & defence was the strongest sector, partly boosted by Germany’s abandonment of the world’s strictest fiscal rules to unlock up to €800 billion for spending in this area.

Against this backdrop, the fund made 3.4%, compared with gains of 0.2% from its IA Mixed Investment 20-60% Shares sector peer group.  

Contributors

Equities drove the lion’s share of the fund’s positive returns.

Aerospace & defence shares rallied given expectations that government spending on this area as a proportion of GDP in NATO ex-US countries will rise significantly. As a result, the order books of the defence companies that we hold (Rheinmetall, BAE Systems and Mitsubishi Heavy Industries) are growing substantially, as are earnings and dividends.

Banks also did well, particularly in Europe (Commerzbank and CaixaBank). Continued strong profitability from higher interest rates, strong cash returns through a combination of dividends and share buybacks and a wave of bids and M&A activity (particularly in Italy) all contributed positively to the sector's performance.

A lack of exposure to US technology contributed to performance from a relative point of view. Given our focus on an attractive level of income, we do not invest in the Magnificent Seven and the like. Technology was the weakest sector globally during the period as China mounted a challenge to US AI dominance in the form of DeepSeek, while concerns rose about the potential impact of tariffs on profits.

In fixed income, our Treasuries and TIPS (Treasury Inflation-Protected Securities) made a positive contribution as bond yields fell, although they rose sharply (especially on TIPS) after the end of the reporting period.

Detractors

General Motors shares sold off with autos more broadly as a result of tariff concerns (it has a large manufacturing presence in both Mexico and Canada). However, earnings have thus far remained robust and management has guided for expected FY25 free cashflow generation of $12 billion (significantly ahead of the $7.5 billion consensus). This would leave the shares on a 2025 free cashflow yield of 25%, an undemanding valuation to say the least. We will continue to monitor policy developments with interest, but still believe GM to be relatively well placed and with ample headroom to increase shareholder returns.

Another significant detractor was Hon Hai, which sold off on concerns around AI demand and tariffs (the company plays a significant role in Apple’s supply chain). The stock is one of many positions that we are debating at present, but on a P/E of 11x, a dividend yield of 4% and a net cash balance sheet, the valuation looks compelling.

Activity and positioning

In equities, we have been adding to ‘core income’ sectors and have been reducing cyclicality in the portfolio. We do however retain a material exposure to financials, which are equipped to deliver double-digit annual cash returns and are well capitalised and well provisioned for a hit to profitability and/or deterioration in their credit books. We believe that these utility-like returns are sustainable, but the market will test this view if the regime change that we have long argued for is expedited by a tariff-induced recession.

When it comes to bonds, we have sold some Treasuries and added to TIPS, given the latter underperformed at the end of the period, which we do not believe to be logical. Elsewhere, there have been some selective opportunities to pick up some bargains in the higher-quality short end of high yield (which constitutes about 25% of the portfolio).

Outlook

Since Liberation Day and what many investors have since referred to as the ‘chart of death’ unveiled by Trump, equity markets have lurched lower (with several entering bear market territory) as investors have attempted to reconcile the effects of sweeping US tariffs on the majority of its trading partners. Despite postponements and reductions to most tariffs in recent days, uncertainty still looms large. We would offer the following thoughts at this stage:

1. The probability of recession has increased significantly: Corporate uncertainty is much higher, with the return on invested capital of new investments highly questionable given a more unpredictable environment. As a result, corporates are less willing to commit, while consumer confidence is also likely to fall (having already done so in the US). The big question we are weighing as a team is whether this leads to a recession, as that would damage corporate profits and multiples.
2. We are likely at or past peak tariffs: Uncertainty is always challenging for markets, and this is amplified when valuations are high. Given just how uncertain the outlook remains at this stage, we have seen something of a ‘shoot first, ask questions later’ attitude from investors, with significant profit-taking from some of the strongest-performing areas year to date, such as European banks and defence. Despite weak equity markets, it was likely the disorder in the bond market – with Treasury yields climbing despite the S&P 500 selling off – that forced Trump to announce the 90-day suspension to reciprocal tariffs. This sparked a significant relief rally, with the Nasdaq climbing 14% in dollar terms, its third-largest daily gain in history.
3. This is more evidence of regime change: Trump’s aggressive rollback of the global order and the norms that have underpinned global trade over the past 30+ years play into our roadmap of regime change. The world is de-globalising and these tariffs look problematic for global platforms in particular. The Magnificent Seven are totemic examples of these sorts of businesses – take Apple, which designs products in California and assembles them in Taiwan with Chinese components before selling them all around the world with little friction. The viability of this sort of model looks more challenged going forward. ‘National champions’ may be better equipped to weather this sort of environment; that is to say businesses that produce and sell their products domestically and are therefore relatively well insulated from protectionism and de-globalisation. None of this is good for markets as a whole. Supply chains will be more inefficient, with a higher degree of deadweight loss.

Despite this volatility and uncertainty, we think the outlook for a portfolio like ours remains compelling. Largely, we are positioned for the regime change that continues to play out across markets, in the form of a deglobalising, more unpredictable world with structurally higher inflation and interest rates. It follows that the asset classes and companies that were the winners in the quantitative easing era from 2009 to 2020, many of which – given high valuations and underwhelming income credentials were not natural fits for a portfolio like this – are unlikely to be those that win in the totally different world in which we find ourselves today.

As a result, our opportunity set remains significant and as income-seeking investors our investment universe is as large and compelling as it has been for a number of years. In uncertain times like this, the certainty of income and its ability to compound and grow over time is incredibly powerful. We are optimistic as to the portfolio’s ability to continue to compound income and deliver attractive returns for our investors going forward.