Artemis Global Income Fund update

The quarter was characterised by the continued dominance of the mega-cap US technology titans

The remarkable rally in the Nasdaq 100 continued, with the result that it returned 39% in US dollar terms in the first half of 2023 - its best start to a year for four decades.

These gains were driven by excitement about artificial intelligence and underwritten by an injection of liquidity designed to ease the tensions in the US banking system. The result was a rapid expansion of earnings multiples. The Nasdaq’s price-to-earnings ratio shot up from 22x at the beginning of the year to 33x by the end of June.

The Nasdaq 100 has dramatically outperformed MSCI World over the year to date. Can this continue? 

Japanese equities also performed well

In Asia, China’s economic recovery continued to disappoint, obliging the central bank to cut interest rates to stimulate activity. Japan, on the other hand, has been one of the strongest performing equity markets over the year to date, with the Topix closing at its highest level since 1989.

The fund lagged the market, largely due to not owning mega cap tech stocks

The fund returned 1.0% over the quarter versus a return of 3.3% from the MSCI AC World Index

Rarely have companies that we don’t own accounted for such a significant proportion of our underperformance. Two-thirds of our underperformance can be attributed to our underweight in the technology sector. This is partly structural, given the low (or in many cases zero) dividend yields on offer here. But it also reflects our wariness towards stretched valuations.

US pharmaceutical company AbbVie was our largest single stock detractor

AbbVie's shares fell by almost 20% on the quarter. Sales growth from several of its newer therapies came in slightly below expectations and investor concerns around the pricing controls imposed by the Inflation Reduction Act compounded the weakness.

We have been surprised by how weak the healthcare sector has been, given its attractive defensive characteristics and historic outperformance going into recessionary environments. We have, however, reduced the portfolio’s exposure to healthcare due to our concerns around the implications of the Inflation Reduction Act. For now, there are better homes for our clients’ capital in other regions and sectors.

Defence companies BAE Systems and Rheinmetall also underperformed

The catalyst seemed to be optimism around Ukraine’s counter-offensive spurred by the chaotic events unfolding in Russia. Even if there is a speedy resolution to the conflict, we believe both companies are well placed to deliver significant growth in their cashflows and dividends over the medium-to-long term. There has been a structural shift in global defence policy and in spending commitments.

Our holdings in financials fared better in the second quarter

Several of these companies, particularly banks, released strong results, underscoring the power of higher interest rates to boost their earnings. Many banks have a multi-year, double-digit return profile thanks to a combination of dividends and share buybacks. We believe this is an attractive prospect, particularly in today’s uncertain environment.

We reduced our underweight position in the technology sector and added airlines

We added to our position in Broadcom. Its 2.5% dividend yield and strong record of growing its dividend (38% compound annual growth rate between 2016 and 2023) makes it one of the few large technology companies suitable for a fund designed to generate income.

Elsewhere, we bought shares in Ryanair and Singapore Airlines. Capacity across the industry remains well below its pre-pandemic levels and demand for travel has been robust, resulting in an attractive pricing environment for airlines.

Japanese equities now account for 13% of the portfolio

This is our highest weighting to Japan since the fund’s launch. Japanese companies tend to have strong balance sheets (50% are net cash) and are often attractively valued (around half of the Japanese market trades on less than book value). The country has finally broken free from the damaging grip of deflation but does not face the runaway inflation seen in many parts of the world. Modest inflation is incentivising domestic investors to return to equities and corporate governance reforms continue to unlock shareholder value.

Outlook

It has been a challenging six months for our dividend-focused strategy. Long-duration mega-cap technology stocks have outperformed all other areas of the market since liquidity was injected to shore up the US banking system in March. At the same time, companies with high free cashflows and above-average dividend yields have underperformed markedly, resulted in a tough environment for income-seeking investors.

The narrowness of returns from the global market has been staggering - just five stocks account for 50% of the returns that our benchmark index has generated over the year to date. Despite this narrow leadership – and the concurrent underperformance of much of our portfolio - we retain our broad positioning. We still believe in our ‘regime change’ thesis; the inflation genie is out of the bottle and continues to spread into services and wages, and we foresee an environment in which interest rates remain higher for longer than is currently priced in by the market. The US government needs to issue huge amounts of debt to refill its coffers – a natural drain on liquidity from the financial system. Central banks, meanwhile, must shrink their balance sheets, which is likely to have a similar effect. We therefore regard events of recent months as a temporary detour; our long-term roadmap remains unchanged.