Artemis Funds (Lux) – Global High Yield Bond update

Source for all information: Artemis as at 30 September 2024, unless otherwise stated.

Objective

The fund is actively managed. It aims to increase the value of shareholders’ investments through a combination of income and capital growth.

Performance

The fund returned 4.4% during the three months to the end of September, behind the 5.0% from its ICE BofA Merrill Lynch Global High Yield Constrained USD Hedged index benchmark.

As we have mentioned in the past, we tend to lag large rallies given our lack of ETF-exposed bonds (this conversely helps us whenever markets suffer downside volatility). We also suffered from our underweight in CCCs and our focus on the front end, lower-duration part of the high-yield market.

The story of the year so far has been one of making sure that downside credit protection is intact while allowing coupons to deliver the ‘base’ of total returns, topped up with a number of small upside moves in select credits. In other words, this year has neither seen a volatility event large enough to create value, nor a dislocated market full of mispriced bonds. However, we are pleased with our performance. We have avoided large credits with significant issues and found a few (generally lower beta) ideas that have given some additional outperformance.

Year to date, we have made 10.2% against an index return of 8.7%. This has been despite getting a lot of our top-down positioning wrong – we have been short CCCs (which have returned 16.0% compared with 7.9% from BB-Bs); short the long-end (which has marginally outperformed); and had zero in emerging market high yield which has also done well. In short, the wind has been blowing in our face all year. To have outperformed in this environment shows how much value can be added through credit selection.

Positives

Holdings in property and related sectors dominated our list of top performers during the quarter, aided by falling interest rates. Our position in Swedish residential landlord Heimstaden was the pick of these on the back of a rebound in local property prices and increasing rents. We saw a recovery in Medical Properties Trust, a REIT, following the successful resolution of a bankruptcy by one of its larger tenants. Czech landlord CPI and US homebuilder New Home Company also did well.

Elsewhere, our holding in infrastructure contractor Kier Group rallied on the likelihood of increased government spending and improved sentiment towards the UK following the general election.

Global auction house Sotheby’s was another strong performer after it announced a combined $1 billion equity injection from existing owner, Patrick Drahi, and Abu Dhabi-based sovereign wealth fund ADQ. When it was announced that most of the funds were to be used to repay debt, the bonds jumped by about 17 points.

Negatives

One of June’s top performers, French fashion retailer Isabel Marant, ended up as our worst performer during the quarter due to weakness in the luxury sector. While frustrating, we feel the position earns its keep: its recent fall was driven by external factors and it has a yield in the mid-teens, so we feel we are being well compensated.

Our position in US equipment distributor and rental firm Alta Group also held us back due to a disappointing outlook for the remainder of the year. Car sealing-systems maker Standard Profil was another laggard. Our conviction in its bonds declined along with their performance, and we sold out.

Activity

We took part in a new issue for French optometrist chain Alain Afflelou, which we see as being attractively priced given its low cyclicality, strong market position and resilient franchising model.

Frozen food retailer Iceland continues to surprise with the quality of its earnings, as falling energy costs help to boost margins. Additionally, we feel close competitor Asda has lost management focus and as such there is an opportunity for Iceland to increase its market share. Although historically we have been sceptical of the business, we have finally bought in. As Keynes almost said: “When the facts change, we change our mind.”
We also topped up positions in Carnival Cruises and US homebuilder Dream Finders Homes.

We exited our position in Victoria Carpets, following rumours it was considering a potentially disruptive fundraising. While our bonds were relatively insulated from any negative implications of the fundraising, this action fundamentally disrupted our view of the company’s value.

Another position we sold was US golf cart manufacturer Club Car, which has been struggling to compete against cheaper Chinese imports. In our view, the valuation didn’t reflect this growing threat and what would happen if the market began to take it more seriously, as it has done in autos.

Alongside these we also took profits in Itelyum (Italian oil recycling), Miter Brands (US window maker), Neopharmed (Italian pharma) and RAC (UK car breakdown).

Outlook

We are entering a new phase for liquidity in the market. The Federal Reserve, European Central Bank and Bank of England have all started their cutting cycles, while China has announced a significant boost in stimulus. There is an awful lot of liquidity starting to slosh around the system. Alongside this, enormous sums in money-market funds are going to be transferred into other assets as rates are cut and returns start to drop.

The following elements mean that this injection of liquidity into markets could significantly benefit high yield:

1. For yield-focused investors (and most investors in money-market funds generally fit this bill), high yield is one of the few global markets in which you can lock in yields of more than 7%.
2. Unlike most other markets, high yield has not been the subject of capital inflows over the past five years (the market has had cumulative outflows of about $60 billion since the start of 2018).
3. The owner base has moved away from more flighty investors towards more structural, buy-and-hold owners such as insurance and pension funds (Bank of America estimates that the latter two segments now own 39% of the US high-yield market).
4. The overall high-yield market has grown by just 2.3% over the past decade, due to bonds being upgraded and issuers instead using cheaper sources of funding. This compares with 61% for global investment grade bonds, 39% in global government bonds and 104% in global equities.

It is not unreasonable to suspect that at least a small part of this excess liquidity being pumped into the system will make its way into high yield. Given the technical backdrop (a smaller scale of market with a larger share of permanent owners), this is likely to have a greater impact on this asset class than on others.

Think of it like this – high yield is currently at the end of a relatively small pipe (due to a smaller market size and a larger share of flows being dominated by structural owners). At present there is a small trickle coming through, supporting valuations where they are today. As liquidity starts to slosh around the global financial system, some will likely find its way into the high yield pipe. Because of the size of the pipe, the pressure will be higher – which will likely keep spreads compressed and support performance.