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

Source for all information: Artemis as at 31 December 2023, unless otherwise stated.

Performance

The fund made 4.2% in Q4, compared with 1.4% from its Sterling Overnight Index Average (SONIA) benchmark.

Central banks were the main driver of performance during the quarter, with the bond market rallying on renewed hope of a dovish Federal Reserve pivot. At the start of November, the central bank noted financial conditions had tightened ‘significantly’, while inflation later surprised to the downside. This translated into a rally in government bonds and risk spreads, driving monthly returns not seen since the recovery phase of 2020.

We lagged behind our peer group in the quarter, but our total return of 12.0% for the year made us the second-best performer in our sector of 23 over this time. The fund has now delivered top-quartile returns over one, two and three years.

At the individual security level, the biggest contributors to performance over the quarter included specialist chemicals business INEOS Styrolution and pharmaceutical manufacturer Cheplapharm, both from Germany; and UK homebuilder Miller Homes. We took some profits from Cheplapharm.

The three biggest detractors were German high-end manufactured wood producer Pfleiderer, which suffered from cyclical concerns; Swedish residential real estate company Heimstaden, which has been hit by problems facing the wider property sector; and Israeli energy holding Leviathan, which fell following Hamas's attack in October.

In terms of ratings, the fund's avoidance of CCC-rated bonds hurt relative returns towards the end of the quarter, as some of our riskier peers’ allocations to this area benefited from the market rally. Ultimately, we believe that CCC-rated bonds – with their probability of default almost 50x higher than BBs – don’t make sense as a structural allocation with our low-volatility approach.

Activity

Purchases

Early in the quarter, we bought auto dealer Penske Automotive, waste management company GFL Environmental, concrete pumping service provider Brundage-Bone and industrial process software provider PTC.

Later on, we bought Raising Cane's, a US fast-food chicken restaurant, and Paprec, a recycling company that we have owned before. We also participated in the refinancing of ams Osram, an Austrian producer of advanced sensors we have owned for several years.

Activity continued into December, which is usually a quiet month, with a new issue from French equipment-rental company Loxam and two small positions in the European real estate sector, Aroundtown and CPI.

Sales

In oil & gas, we sold positions in Energia and Ithaca Energy and trimmed our holding in Harbour Energy after a strong run in the sector. We also reduced our Israeli energy exposure via a partial sale of Leviathan.

We sold our position in Ancestry.com (the online genealogy business). While we like the company, we believe it is carrying too much debt following a large releveraging transaction and don't believe bond holders are adequately compensated for the risks this entails.

In US housebuilders, we took profits from Dream Finders Homes and recycled them into LGI Homes, which has lagged significantly behind.

The quarter saw us buy and then sell a position in hotel group Hilton Worldwide, following strong performance in a short period.

Outlook

After a significant rally in high yield over the past couple of months, we expect a bout of turbulence in the first quarter of 2024 – it is usual at this time of the year and seems more likely given how far the market has come in such a short space of time.

However, for investors with a medium- to long-term mindset, this area of the market still looks attractive. Yields remain at historically attractive levels, central banks appear more open to loosening monetary policy through rate cuts, and credit risk looks reasonably healthy given conservative balance sheet management and a benign global economy.

We believe short-dated high yield to be particularly attractive in today’s market due to the prospects for early calls. In general, issuers call high-yield bonds (redeem them early) rather than waiting until maturity, for a variety of reasons. In particular, there is an incentive to call bonds before they are within 12 months of maturity, otherwise they move from being long-term liabilities to current ones, creating a range of implications for chief financial officers.

Given the current cash price of our holdings is less than 96, the vast majority of bonds in our portfolio are pricing to their yield at maturity. This is unlikely to be the reality however, given companies tend to take out bonds early. The average maturity in the fund is 2.8 years.

If the bonds in our portfolio were on average called a year earlier (a reasonable expectation), then the 4 percentage points of cash appreciation would need to be discounted over 1.8 years instead of 2.8. This would effectively add about 0.9% to the current yield to worst of 7.7%.

This isn’t reflected in the market’s pricing of risk, which creates opportunities to buy bonds from high-quality companies with underpriced upside from early calls. We also expect some attractive new issuance in the coming months (some of it will likely be used by companies to fund the calls of bonds we own) which will provide attractive longer-term opportunities.