Artemis Monthly Distribution Fund update

Review of the quarter to 30 September 2023

The fund returned 2.5% over the quarter, ahead of its peer group, the IA Mixed Investment 20-60% Shares Average, which fell slightly, by -0.2%.

Most of this strong performance came from the fund’s equity allocation. The strength of the global economy and elevated inflation led to the Federal Reserve hardening its commitment to 'higher for longer' interest rates. As such, the most expensive, lowest-yielding areas of equity markets sold off – areas to which our exposure is very limited – and the more moderately valued (and higher dividend yield) companies in which we invest performed better.

Among the best contributors on the equity side were Japanese holdings. Mitsubishi UFJ Financial Group rose strongly on the prospect of Japan raising interest rates and abandoning yield-curve control. Mitsubishi Heavy Industries also did well as earnings came in well above analyst expectations, with a significant increase in orders in its defence division. We continue to think that Japanese value stocks trading on modest p/e multiples appear to be among the best places for us to hunt for income. Elsewhere, in a period of robust energy prices, oil-related stocks did well. These included Baker Hughes (energy technology) and Tenaris (steel tubes for the energy industry).

On the fixed income side, exposure to US TIPS (treasury inflation protected securities) detracted from performance. TIPS were caught in a pronounced selloff in US government debt as yields spiked given expectations of interest rates remaining higher for longer. We retain a positive stance on TIPS as the real yields available (2.6% above inflation in the case of the 20-year bond) are attractive and we believe they act as an effective 'risk off' hedge.

Activity

In the equity portfolio, we reduced our exposure to ‘defensives’ that weren’t acting like defensives. They included medical device maker Johnson & Johnson and consumer staples stocks Kraft Heinz and Unilever. Staples have not provided the defensive characteristics we might have expected, so we were happy to recycle some of this capital elsewhere. Some of the additions were companies that we thought would benefit from fiscal stimulus and construction spending rather then monetary stimulus. These included CRH and Baker Hughes. We also continued to add to our holdings in banks, where we see attractive dividends and upgrades to earnings. Recent additions included KB Financial, Standard Chartered and Danske Bank. We think interest rates are going to stay higher for longer and this will continue to result in higher lending margins across the sector. Elsewhere, we increased our exposure to Brazil, where substantial dividends are on offer from high-quality companies. We added to oil company Petrobras and have exposure to the country through Banco do Brasil.

In fixed income, we added a number of new issues. One example was Energia, an Irish power producer that holds several attractive long-term power supply contracts with many of the large technology companies based in Ireland, as well as a stable retail electricity business. We also bought a new issue from Yorkshire Building Society. We increased our exposure to Williams-Scotsman, the leading provider of modular and temporary office and storage space in North America. The business benefits from a very diverse range of industry exposures ranging from government and education to construction and wholesale trade. Having an $8bn equity market cap but a grand total of three bonds outstanding which account for only 7bps of the global high yield index, it is an excellent example of the sort of exposures we favour. Other names added included Nestle, Deuce Finco, Volkswagen and a senior bond from Bank of America

In general we see a lot of value in shorter maturities in the credit markets, as inverted yield curves and a reasonable level of spread premium provide attractive levels of yield in securities that tend to exhibit much lower levels of volatility than longer-maturity parts of the credit markets.

Outlook

The Federal Reserve appears to have finished pushing rates higher. Historically, the ‘pause’ between rate hikes and rate cuts has been positive for long-dated bonds and so for long-duration assets. This time around, however, things are different… Bonds are not doing what they ‘normally’ do when the Fed pauses after hiking and yields are going higher rather than lower. Bond yields look to have markedly broken out of a multi decade cycle of compression: the US 10-year yield is at its highest level for 15 years.

This has resulted in an attractive environment for income investors given the valuations offered by high-quality income generating assets. We are therefore optimistic as to the portfolio’s ability to generate attractive income and total returns over the medium term. We will continue to look for good-quality resilient companies producing high levels of income.