Artemis High Income Fund update
David Ennett, Ed Legget and Jack Holmes, managers of the Artemis High Income Fund, report on the fund over the quarter to 31 December 2024.
Source for all information: Artemis as at 31 December 2024, unless otherwise stated.
Performance
Over a choppy quarter for financial markets, the fund generated a modest positive return of 0.5%. It thereby, outperformed its peer group, the IA’s £ Strategic Bond sector, where the average fund fell by 0.6%. That strong relative performance capped off a good year in which it produced a total return of 10.0%, significantly ahead of the average return of 4.4% from its peer group.
The fund is in the top quartile of the IA’s Strategic Bond sector over periods of one, three, five, 10 and 20 years, highlighting just how powerful harnessing income in an unconstrained way can be.
| Q4 2024 | One year | Three years | Five years | |
|---|---|---|---|---|
| Artemis High Income Fund | 0.5% | 10.0% | 9.7% | 18.2% |
| IA Strategic Bond | -0.6% | 4.4% | -0.9% | 6.4% |
| Quartile | 1 | 1 | 1 | 1 |
Contributors
Over the quarter, the fund saw strong performance from some formerly unloved holdings such as:
- Swedish real estate company Heimstaden
- Construction equipment Alta Equipment
- Auction house Sotheby’s
Our holding in Annington’s bonds performed particularly well following a tender offer by the company at a significant premium to their market price. This business owned a large portfolio of residential properties which it leased to the UK Ministry of Defence. During the quarter it reached an agreement to sell those properties back to the MoD for £6 billion. It will use part of the proceeds to buy back the majority of its outstanding debt.
Among the fund’s equities, holdings in Barclays, NatWest, Melrose and 3i all made useful contributions to performance.
Detractors
On the negative side, the single biggest detractor was a holding in the shares of Vistry, a UK housebuilder. It had been one of the fund’s strongest performers in the second quarter but disappointments through the second half of the year saw it becoming a negative. The most recent warning, which came on Christmas Eve, was a disappointing end to the year. While previous warnings had been focused on specific sites in Vistry’s southern division, this one was due to weaker sales in private markets as well as delays in completion ahead of the year-end on some of its larger projects.
In a quarter that saw government bond prices coming under pressure due to worries about trade wars and potentially inflationary government spending, the biggest negative on the fixed-income side tended to be the fund’s holdings in government bonds.
Activity
We used the rally that followed Donald Trump’s election victory to rotate out of some positions where we deemed the future had become slightly less certain and into bonds issued by companies with more resilient earnings streams.
We added bonds from two of the highest quality businesses in the high-yield market: Coty and IGT. Both companies have recently been upgraded to investment-grade status by at least one ratings agency, and we believe they will see further upgrades in the coming months. This should result in their inclusion in investment-grade bond indices and becoming the subject of significant buying by price-insensitive index funds.
We added a position in Asmodee, a producer of table-top board and card games. This part of the leisure market is growing driven by a combination of new and appealing game concepts and consumer desire for cost-effective entertainment. Asmodee is a leading player in this market, with a number of strong product lines including Exploding Kittens, Ticket to Ride and trading card games such as Pokemon and Magic: The Gathering. We like the company’s diversified portfolio of strong brands and can see the potential for a significant deleveraging transaction, one that has yet to be reflected in the price of its bonds.
We bought a newly issued bond from Domestic & General, the provider of insurance for home appliances. We like the fundamentals of this business due to the recurring nature of revenues, attractive margins and its strong market position.
Sales included Medical Properties Trust, a US-headquartered hospital real estate company. While its bonds performed well in 2024, this has not been a success story over the longer term. We bought its bonds before the pandemic. At that point, the company’s financial position was improving and we believed it would eventually acquire an investment-grade rating. Covid, however, was a difficult period for the company as the operators who rented its hospitals were forced to focus more on low-margin care for Covid patients rather than on higher-margin discretionary surgery. From 2022, the rise in interest rates began to have an impact on Medical Properties’ balance sheet. The company has been attempting to manage the issues facing it and the bonds saw a reasonable recovery in 2024, delivering a total return of 13.8%. We therefore took the opportunity to sell.
Other sales included bonds from Multiversity, an Italian online university and Bertrand Franchise, a French restaurant group which own rights to Burger King in France.
On the equity side of the portfolio, we added exposure to Aviva following news that its acquisition of Direct Line looked likely to go ahead. We believe the transaction will be helpful for Aviva. But even if it falls through, the 7.5% yield on the company’s shares more than justifies the position. To fund this addition, we took some profits in DS Smith and reduced the size of our holding in BASF.
Outlook
Given its focus on finding income, the fund tends to focus on high-yield bonds.
Spreads in the high-yield market are towards the low end of their historic range. So, there is degree of scepticism towards the high-yield market, and it is impossible to argue that spreads represent a ‘once-in-a-lifetime’ opportunity. Equally, however, there are a number of reasons to believe that high-yield bonds are well-placed to prosper, particularly the shorter-dated securities we are currently focusing on:
(i) Fundamentals are strong – economic growth is reasonable, and leverage and interest cover are at historically robust levels.
(ii) It is yields rather than spreads that drive returns from high-yield bonds – particularly for short-dated credit. With the high-yield indices generating yields of 7% (Bloomberg US Corporate High Yield Total Return Index), future returns look attractive.
(iii) The technical setup is strong – corporate bond markets (particularly high yield) are shrinking, even as demand for yield is rising. When supply is falling and demand is rising, prices tend to move higher.
We think growing, dividend-paying equities provide a useful tool to income-seeking investors in today’s environment.
Bonds are great at providing current income, but they have no ability to grow that income over time. Dividends are less reliable but have the capacity to grow over time. So, owning income-paying equities helps with our income objective. But they are also useful for portfolio construction. For example, we believe the equities of many companies in the banking sector offer a more compelling proposition for income-focused investors over the next five years than their bonds. Today, equities are a small (15%) but important portion of our total portfolio.
We see two main risks to risk assets in 2025
These risks sit at opposite ends of the spectrum:
- In a ‘risk off’ scenario, a significant downturn in the economy leads to concern about the health of corporate fundamentals. In this scenario, we believe that the strong fundamentals and chunky starting yields on high-yield credit will help to cushion the impact of any widening in spreads.
- Alternatively, a combination of stronger economic performance and worries about inflation may cause central banks (notably the US Federal Reserve) to stop cutting rates. In this scenario, we think our focus on shorter-dated high-yield bonds will help to protect the portfolio due to their lower sensitivity to interest-rate risk and higher levels of carry.
Overall, we think there are good reasons to believe that risk assets (credit and equities) will do well in 2025 thanks to a combination of robust fundamentals and a strong technical backdrop. However, given the potential for downside surprises (and the reasonably tight levels of spreads) we are not positioning the fund for any material further tightening in spreads in 2025. We believe focusing on shorter-dated bonds, harnessing high levels of yield and exploiting idiosyncratic single-name opportunities when they present themselves provides the optimum balance between risk and reward.