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 March and their views on the outlook.
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.
The Artemis High Income Fund’s objective is to provide a combination of a high level of income and capital growth, before fees, over a rolling five-year period. The managers define a high level of income as equal to, or in excess of, the average yield of the funds in the Investment Association sector, the Strategic Bond sector.
In searching for attractive sources of income, the majority of the fund is invested in bonds – particularly high-yield bonds – but it also has the capacity to invest in company shares:
- High-yield bonds – Holdings in high-yield bonds are at the heart of this fund. These are issued by companies that ratings agencies (such as S&P and Moody’s) deem to be at greater risk of defaulting on their debts. As their name suggests, they offer a higher ‘yield’ (rate of interest) to compensate for the higher level of risk.
- Investment-grade corporate bonds – These are issued by companies with higher credit ratings. These are businesses that ratings agencies consider to be at relatively low risk of defaulting on their debts.
- Government bonds – These are widely viewed as being among the safest bonds (governments in developed economies rarely default on their debts). The interest rate, or ‘yield’, available here is lower than it is on high-yield and investment-grade corporate bonds – but they can provide a useful counterweight to the fund’s holdings in more economically sensitive bonds and shares.
- Dividend-paying equities – These are shares in companies that return a portion of their profits to their shareholders through regular cash payments (‘dividends’).
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 to 31 March 2024, 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.
| Performance to 31 March 2024 | Q1 2024 | One year | Three years | Five years | 10 years |
|---|---|---|---|---|---|
| Artemis High Income Fund | 3.5% | 11.4% | 6.5% | 17.3% | 43.9% |
| >£ Strategic Bond NR | 0.9% | 7.1% | -2.2% | 8.1% | 27.2% |
| Quartile | 1 | 1 | 1 | 1 | 1 |
| Annualised performance 12 months to 31 March | 2024 | 2023 | 2022 | 2021 | 2020 |
|---|---|---|---|---|---|
| Artemis High Income Fund | 11.6% | -3.9% | -0.6% | 23.2% | -10.6% |
| IA £ Strategic Bond NR | 7.1% | -6.5% | -2.3% | 12.6% | -1.8% |
Review: avoiding bond market blow-ups and profiting from a rally in UK banks
The primary driver of returns this quarter was the strength of the high-yield bond market and the fund’s successful avoidance of three of the poorest performers in the European high-yield market1:
- 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 too much debt – particularly in the telecoms sector – were at risk of running aground once the reality of higher interest rates hit. We think recent problems at Altice, Ardagh and Intrum may prove to be 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 which may prove to be a beneficiary if (or when) interest rates move lower.
UK high-yield names 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.
Our holdings in the shares of UK banks NatWest and Barclays both made useful contributions to returns over the quarter. Their lending margins disappointed last year but this is starting to change. Better-than-expected results are helping to convince investors that better times are ahead for UK banks. We tend to agree.
Housebuilder Vistry 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 Barnet2.
Changes to the fund: 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 choose to use new borrowing to repay bonds early that the market had expected to remain outstanding for a while and, in the process, provide a nice capital gain to bondholders.
Similar ‘refis’ are happening elsewhere, and we have actively been setting up the portfolio to take advantage of these opportunities. So 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 (European real estate) following their strong rally. We also sold our holding in LKQ (a US auto repair/parts distribution business) following significant tightening in the ‘spread’ (the additional premium that corporate borrowers must pay to borrow over and above government bonds).
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 riskier assets such as high-yield bonds and shares. The beauty of today’s market conditions is that, in contrast to the long period when bond buying by central banks (quantitative easing) held yields down, we can harvest attractive levels of ongoing yield from high-yield bonds and use them to generate an attractive total return.
2Vistry Group selected as Preferred Developer to deliver £276m scheme for 739 new homes in Barnet | Vistry Group