Artemis Short Duration Strategic Bond Fund
Q1 2025 update

Overview

Gilts were the main discussion point in January. The market was weak in the first half of the month before mounting a strong recovery and ending up pretty much back where it started. This weakness was part of a global trend, with US Treasuries also falling on strong employment data. The UK did underperform on the way down on concerns about an unpopular government and a Budget that the market didn’t warm to. But this was no Liz Truss moment.

Bond vigilantes aren’t back, but they have polished their shoes and are ready to step out. There isn’t much room for more missteps. Our view is that gilt yields will end the year lower as base rates are simply too high for the mediocre growth environment. The Bank of England will have to focus more on low growth rather than the slow pace of falling services inflation.

February saw credit spreads reach their tightest point since early 2022, before creeping out towards the end of the month, but there were no wild moves. Gilts remained rangebound throughout and, even with some strong intraday and intraweek moves, they finished the month relatively unchanged.

Credit spreads then moved sharply wider in March. Some of this was due to market fears over the economic impact of tariffs initiated by the US. Then again, credit and equity markets have enjoyed a bull run, so perhaps they were due a reset and correction. Spreads essentially gave up all their gains over the past six months.

The fund made 1.4% during the three months to 31 March, ahead of the 1.3% made by its benchmark (the Markit iBoxx 1-5 year £ Collateralized & Corporates index; before 18 March 2024 it was the Bank of England base rate +2.5%).

Given the volatility and size of the moves in rates markets, we are happy to be ahead of our benchmark for the quarter to date.

Rates (government bonds)

Rates performance was positive in January. Bonds opened weaker, with our curve-steepening positions in the US performing well. We reduced the size of these into mid-month and as yields rose the fund began selectively adding a small amount of duration exposure across US real-yield positions and Swedish government bonds, as well as UK and US curve trades, cross-market gilts versus Treasuries, and Canada versus Japan.

At the start of February, we increased exposure to New Zealand and Swedish government bonds as both had underperformed, selling gilts and Treasuries to pay for these positions. We also reduced our 'long US versus EU real yield' position which had performed strongly, although we retained a core holding in this strategy of 0.2 years by directly reducing the existing position in TIPS (Treasury Inflation Protected Securities) and by buying 10-year German real yields. We closed our short Japanese 10-year x-market trade versus US and other dollar bloc markets (admittedly too early). Japanese rates underperformed significantly in the rally post mid-January into mid-February.

The fund began March with duration of close to 2.6 years and ended the month close to three years. We began with a sizeable short in European duration, which worked well as the German fiscal announcement caused large underperformance. We spent the second half of the month reducing this short while cutting 10-year gilt duration.

We have also flipped some of the short German risk back into short Japan 10-year rates after a large move post-fiscal announcement. At the same time, we added exposure to Swedish rates which had been dragged higher by the German story and some hotter domestic inflation data, causing the Riksbank to suggest its cutting cycle was over. We added Swedish rates because the curve was pricing in modest tightening which we believe is incorrect. Our Swedish rates strategy is now the fund's largest rates position. We hold this for a carry and roll perspective rather than expecting an immediate pivot towards potential cuts from the Riksbank. Sweden is the only economy (bar Japan) where further easing is not currently priced.

Our overweight bias in US real yields and a US curve-steepening position also helped fund performance in March as US breakevens rallied and the curve steepened in response to rising tariff concerns. We have reduced steepening exposure and US real-yield exposure following a strong period of performance in both strategies. We added short European inflation exposure, bringing our overall inflation exposure in the fund at the end of the quarter closer to neutral.

Credit

New issuance rose in January but was still more muted than historical levels. We bought new issues from BMW, Mercedes-Benz, Santander and J Sainsbury, all of which traded well, and carried out relative value switches in Barclays and Mitchells & Butlers bonds. We also initiated a new pair trade, going long Deutsche Telekom and short KPN.

February was a busy month for new issues. The fund bought Caterpillar, Athene, Central American Bank, Swedbank, BPCE, Volvo and Carnival Cruises. We also bought Aviva and Phoenix in the secondary market. These were funded in two ways: inflows have been healthy, but also from our build-up of short-dated gilts as early-year opportunities were not that abundant or attractively valued.

Credit spreads further widened in March. You could argue this was driven by looming tariffs and the negative consequences they could have for economic growth. But this also coincided with a not unreasonable blow-off of risk froth. After all, the markets have enjoyed a long bull run.

A combination of factors has improved the landscape for redeploying the cash into short-dated corporate bonds. As mentioned, new issues have returned, which is welcome. There are hints of US economic growth not being quite as robust as we have grown accustomed to. And of course, no shortage of geopolitical drama. To that end the fund reduced its holdings in short-dated gilts and reinvested the proceeds into credit. The fund was active in the secondary market and bought BP, Dignity, Resolution Life, Marston's, Verizon and Quadgas. The fund carried out a relative value switch between two Caterpillar bonds and bought one new issue, Bunzl.

On the high-yield side, the fund added a holding in Greystar, the market leader in US multi-family property management, and topped up its holdings in SNF, a provider of water-filtration products. To fund these we trimmed positions in Alain Afflelou, the French optician, and Cvent, the market leader in event management software.

Given corporate health, we still think credit risk is a good place to be. It would be great to buy corporate bonds at wider credit spreads. But short-dated corporate bonds are not the asset class to try and time. The returns have nothing to do with capital appreciation through credit-spread tightening and everything to do with the power of compound interest.

Enjoy the power of compounding interest and never fret about the low beta allocation of your broader portfolio.

Outlook

Higher tariffs act as a headwind to global growth while also raising inflation. We believe central banks will focus on the former and the impact on domestic demand, leading to lower interest rates, all else being equal.

Ultimately, we believe that the US president will back-pedal on aggressive tariffs should it become clear that US growth is falling rapidly. At this stage it's just the survey/soft data that has rolled over while hard data is holding up well. Yes, US consumption was weaker in Q1 and US GDP is tracking more like 1% versus the 3 to 4% seen in Q3 and Q4, but this is more likely a temporary retrenchment amid higher tariff/policy uncertainty. Real income growth is still rising at a healthy clip and the labour market continues to look resilient (we doubt the reduction in federal workers is enough to drag domestic demand into negative territory).

If the administration does not pivot to a less aggressive tariff regime and it’s not, as has been claimed, a negotiating tactic, then a global growth slowdown is inevitable.

However, we believe a more significant change in fiscal policy globally presents a new wild card for bond markets. What is clear from recent months is that fiscal policy outside the US is set to become more expansionary while the Trump administration is intent on reducing government/federal spending and directing that towards the private sector via tax cuts.

The US is focusing on reducing state/government spending and at the same time forcing other countries to look at greater spending to fund defence spending/subsidies. The difference this time (as opposed to the previous Trump administration) is that the stakes are higher and more immediate for Europe, which is why the German fiscal response has been so shocking. It’s also likely that Canada will boost defence spending.

Across the globe, governments are likely to take a more activist fiscal approach to combat the hardened US protectionist agenda. This means greater spending and greater government bond supply (or EU bond supply in the case of the bloc), compared with the US where the administration is hoping to reduce the deficit from its current level of about 6.5% towards 3% through a combination of tariffs and reduced government spending. This leads us to continue favouring US duration versus peers, while steeper curves remain the most likely path ahead for all government bonds.