Artemis Funds (Lux) – Short-Dated Global High Yield Bond update

The fund returned 1.7% over the quarter, ahead of the SOFR's (secured overnight financing rate) return of 1.2%.

The only significant negative for the quarter was the loss we sustained on our holding in a Thames Water bond. While the issues around their asset base and the need for further investment were well known (and priced) by the market, a combination of factors came to a head in June. The first was the sudden resignation of the chief executive in the middle of key negotiations with shareholders regarding the need for new capital. The situation was aggravated by the UK government – not unreasonably – floating the possibility of forced full or partial nationalization should matters get worse. We took to decision to sell our exposure as in any such outcome the bonds could be severely, if not totally, written down.

Activity

We continued to selectively add bonds in property sector where we see maximum pessimism – much of it warranted – but also many high-quality assets trading at very attractive levels. We bought short-dated (2025) Canary Wharf bonds at a yield of around 12.5%. While the challenges facing the property sector are apparent, we view Canary Wharf’s c£8bn in prime office and retail assets as being more than adequate to cover their £4.2bn in net debt, even allowing for a significant fall in values. In a similar vein, we bought a position in German diversified property company, Aroundtown’s euro denominated 2027 bonds at a yield (in euros) of 9.4%. Aroundtown’s portfolio includes offices (43%), residential (32%), and hotels (18%) and again we see low loan-to-value (35%) and discounted bond prices as providing a firm valuation backstop.

Elsewhere, we established a position in Ancestry.com 2028 bonds, which has been a long-time holding in our longer-dated high-yield strategies. We like Ancestry.com’s stable recurring cash flow position, low leverage, and strong market position. We also took a position in Deutsche Bank senior non-preferred bonds (2025).

Against this, we sold positions in US auto dealership Ritchie Bros. and Italian utility, Enel, as their bonds had performed well and given their (now) limited upside we decided to recycle the proceeds. We also sold International Design Group, the owner and operator of a portfolio of luxury architectural and home brands, and Alsea, the operator of leading restaurant franchises (Starbucks and KFC) in Mexico and Europe.

In May we used the relatively strong performance of higher beta credit to marginally trim some of the risk in the fund. We did this not out of any serious concerns but rather out of discipline and a desire buy more risk in the event of any sell off in markets. We trimmed positions in German online retailer, CBR, following a rally in their bonds after strong Q1 2023 results. In a similar vein we also reduced holdings in US IT provider, CCSI, as well as auction house, Sotheby’s.

Within the auto sector, we made a few changes. We benefited from Adler Pelzer’s refinancing of its 2024 bond of which we were holders. They issued a new 4-year bond at a 12.5% yield and we have taken a position in it, albeit a smaller amount than we had of the refinanced bond. While such a yield should raise a few eyebrows, the company’s fundamentals are sound and it has a record order book. Given sector economics are swinging back towards suppliers following years of plenty for the manufacturers, we have also trimmed our exposure to Ford. We recycled the Ford proceeds into new 5-year issue from US/European car parts distributer LKQ where we have long admired LKQ’s commanding position in the highly stable and cash generative distribution chain.

We took a position in German metering company, Techem, which provides automated individual meter-reading and billing services for buildings with centralised energy and heating. The company enjoys as stable top-line as we ever observe in high-yield companies.

We topped up on AMS bonds as we saw the market's reaction as overdone. While we held some bonds already, we had expected a weak Q1 2023 print and used to sell-off to increase our exposure. We also bought new short-dated issuance from US bank, JP Morgan and insurer, Equitable Holdings.

We bought a new 5-year issue from the world’s largest distributer of auto parts (mainly premium end), UK-based Inchcape. Inchcape is an investment-grade issuer whose new bond at >6.5% yield appeared to be a good way to exploit the attractive yields available in the UK with an extremely robust, listed business. Similarly, we bought fellow UK investment-grade-rated Weir Group’s new 5-year bond at around 6.8%. To us, using a period of gilt volatility and weakness to lock in these yields from globally operating, investment-grade companies is a good risk-reward trade at this point.

In the US we took positions in US homebuilders, Meritage (South and South-West) and Tri Pointe (California and Colorado) as confidence has returned to the sector and in both cases, short maturity bonds look very attractive. Elsewhere, we topped up positions in Premier Foods, Schaeffler, and Teva. Eastern Mediterranean oil and gas producer, Energean, announced its intention to refinance the 2024 bond which is held in the fund, and so we added its 2026 bond to the fund at a yield of around 7.5% in USD terms.

Outlook

The overarching theme of the first half of 2023 has been the creeping fear that while inflation is certainly rolling over, there is increasing uncertainty as to where it rests. Central banks may have to tighten policy more than previously expected to reduce inflation and this has had a significant impact on short-dated bonds. Accordingly, any notions of cuts have been priced out of the market for the end of the year and the conversation has changed from when cuts start after this pause, to whether there will be the need for further hikes after the pause. This change in dynamic is important because it ultimately is likely to influence the extent of economic damage that occurs and by extension what the default picture for high yield looks like over the coming years.

We have broadly leant into our approach in two key ways: we have added higher-quality exposure where we believe we were being well compensated for it, and we have reduced lower-quality exposure where we believe volatility will be felt should recession fears increase further. Broadly, the names we are trying hardest to avoid are over-levered businesses who will struggle with the combined impact of higher funding costs and lower demand. However, investors should take comfort from the strategy’s tiny exposure to CCCs and our disciplined approach to managing volatility. Notwithstanding this, we still retain exposure to cyclical businesses and believe there are outstanding risk/reward opportunities in the current environment. Given the uncertainty around the path of inflation we feel strongly that high-quality short-dated credit exposure with just two years of duration remains a uniquely attractive part of the investment universe.