Artemis Strategic Bond Fund update

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

Performance

The fund returned 4.3% over the quarter, just ahead of an average return of 3.7% from its IA peer group. Over the year to date, meanwhile, it has returned 6.3% versus an average return of 5.0% from its peers.   

Overview

A positive quarter for bond markets saw central banks worldwide responding to easing inflationary pressures and slowing economic growth by cutting rates. Yet while the overall direction of travel was positive, there were periods of elevated volatility. So, while we remain constructive on the outlook for bond markets, these are conditions in which investors are best served not by taking a buy-and hold approach but rather by thinking and acting tactically.    

In August, a number of central banks cut rates. The Bank of England kicked things off with a 5-4 knife-edge vote to lower interest rates to 5%. Sweden’s Riksbank, the Reserve Bank of New Zealand and the Bank of Canada followed suit.  

Meanwhile, a weak US jobs report in early August showed a surprise jump in the unemployment rate.  This triggered the so-called ‘Sahm Rule’, with the bearish interpretation being that the US economy was already in recession. The market’s reaction suggested that, by not cutting rates earlier in the summer, the Federal Reserve had fallen asleep at the wheel. A brief period of market turmoil resulted. The volatility was exacerbated by low levels of liquidity due to the summer holidays, with wild swings across fixed-income, equity and currency markets.  

As August progressed, however, it became clear that the Federal Reserve would rethink its policy stance. Volatility eased and the panic-driven moves in early part of the month began to reverse.   

The bold, 50-basis-point cut subsequently delivered by the Fed pointed to a new, more dovish tone for monetary policy, with other central banks talking up the possibility of more aggressive easing in the months ahead. As markets priced a deeper and faster rate-cutting cycle, yield curves steepened across the board.  

Activity

Government bonds (20% of the fund)

We actively managed the fund’s sensitivity to interest rates over the quarter. Its headline duration began the quarter at 6.3 years, peaked at 6.8 years and ended the quarter back at 6 years.

In July…

We increased the fund’s capacity to profit from rate cuts by adding duration. The catalyst for adding duration in Europe was the significant repricing we saw ahead of elections in France. We also added duration exposure in Australia, which had lagged other bond markets significantly as some analysts called for the Reserve Bank of Australia to raise interest rates in response to higher inflation readings. Our view was that rate hikes in Australia were less likely than the market believed, particularly given New Zealand’s pivot to cutting rates.

Elsewhere, we reduced the fund’s holdings in long-dated UK government bonds, reallocating to the 10-year part of the curve. In late July, meanwhile, we established a position in (2-year) gilts, which we felt offered a particularly attractive balance between risk and reward relative to their global peers. We sold Swedish 10-year rates which had rallied strongly and which, in our view, had begun to look fully priced given the expected path of interest rates.

In August…

With the gilt market underperforming its global peers in August, we rotated our overweight position in Australia into the UK. At that point, the yield curve was implying that base rates in the UK would settle at around 3.5% – significantly higher than in other economies. We viewed this as unlikely.

In anticipation that rate cuts by the Fed would encourage the US yield curve to dis-invert we added a 2-year vs. 10-year ‘steepener’ trade in the US Treasury market. We also reduced the size of the fund’s short position in Japanese government bonds.

In September…

With the Fed’s 50-basis-point cut having eased the pressure on the Bank of Japan to protect the yen by raising rates, we closed out the underweight to Japan. Governor Ueda sounds remarkably relaxed on the need for policy rates to move higher.

Elsewhere, we sold French government bonds. The country’s deficits are coming under increasingly close scrutiny and its deficit-reduction goals look out of reach for its fragile government.

A short-term tactical trade saw us buying 30-year UK index-linked gilts while selling 10-year conventional gilts. We added this position at the start of September and it worked well almost immediately, allowing us to close it out at a profit. We view short-term tactical trades of this nature as a useful way of enhancing returns without adding risk.

We reduced the size of the fund’s short position in Eurozone inflation markets. Although this position had performed well, we anticipated that China’s announcement of stimulus measures in late September could prompt a reassessment of Europe’s economic prospects.

Investment-grade bonds (48% of the fund)

• Meadowhall Finance – We added to one of our highest-conviction positions after Norges Bank took control of this Sheffield-based shopping centre.
• Bank of America – Volatile market conditions in early August provided us with an opportunity to add Bank of America to the portfolio. 
• Rothesay – We moved up the capital structure in UK insurer Rothesay, selling its subordinated (RT1) bonds and buying its more senior (LT2) paper instead.
• Barclays – Within the UK bank sector, we rotated out of Barclays, using the proceeds to top up the fund’s exposure to Lloyds and NatWest. 
• Other additions over the quarter included Heathrow, Pearson, Land Securities and Great Portland Estates.
• HSBC and Santander – We reduced our exposure to two banks, the valuations of these bonds were not as compelling as they had been.
• BNP and BFCM – We sold both holdings, stepping away from the French banking sector entirely.

High-yield bonds (28% of the fund)

• Carnival – We added some exposure to this cruise line operator after a ratings upgrade from Moody’s. It continues to chart a course back to investment-grade status.
• Restaurant Brands International – We bought a newly issued, dollar-denominated bond from the owner of Burger King and one of the world’s largest fast-food operators.
• Keepmoat – We added bonds issued by a UK housebuilder focused on affordable housing.
• ConvaTec (‘180 Medical Inc’) – This is a global manufacturer of wound-care and continence products.
• Azelis – We bought bonds from European specialty chemical manufacturer Azelis at issue. Its products are used in the life sciences industry and in industrial applications.

• IGT Lottery – We added bonds from IGT, which provides technology to the global lottery and gaming industry.

• IHO – We reduced the fund’s holdings in the auto sector earlier this year. But after a difficult period for the industry and a repricing of its bonds, we added back a small position in one of our favoured names. IHO is the holding entity for the Schaeffler family’s holdings in auto suppliers Schaeffler, Continental and Vitesco. It has compelling asset backing and we can see potential catalysts (such as a potential spin out of Continental’s auto business) for spreads to compress.
• Center Parcs – this holiday resort’s impressive ability to push up prices may be approaching its limit.
• Flutter – With spreads on the UK gaming group’s bonds having compressed significantly, it felt prudent to take profits.
• Ocado – We sold our position following a successful refinancing operation. Although we still believe in Ocado’s mission to become a high-margin, high-cashflow technology services company, this was increasingly reflected in the price of its bonds.

Outlook

Although we are still positive on the outlook for bonds, market expectations for rate cuts have moved closer to our own. In response, we lowered the fund’s duration to six years by the end of the quarter from a high of 6.8 years in July. This gives us ample room to add duration back should yields move higher after a summer of strong returns.

Today, the inflation picture in the US is admittedly rather noisy – but the path globally is still towards lower rates. We would caution against reading across too much from (volatile) non-farms payrolls data in US to the prospects for interest rates worldwide. Even if the Fed were to move more hesitantly than was expected a few weeks ago, it would not negate the powerful effect of the global easing cycle. All major developed-market central banks have brought inflation down considerably and, with the exception of the Bank of England and perhaps the Norwegian central bank, they now see the risks as being asymmetric: slowing economic growth is now a greater risk than inflation. Japan is the only clear outlier.

At the same time, we must acknowledge the picture is less clear-cut than it was. In addition to the threat of domestic inflationary concerns in the US, escalation in the conflict in the Middle East poses an upside risk to energy prices. Commodity prices have bounced following China’s surprise announcement of forceful fiscal and monetary stimulus.

To focus more narrowly on the US, our view is that, regardless of the volatility in labour market reports, the Fed has made enough progress on its inflation mandate to continue to ease policy. We can see signs of slack beginning to emerge in other labour-market measures, such the Jolts report, which indicates that employees in the US have grown less inclined to quit their jobs and move elsewhere in search of higher salaries. We also believe the risks confronting the Fed are asymmetric. A period of weak growth and lower inflation would be a toxic mix given the country’s persistently high deficits and increasingly onerous government debt burden. Surely it is better for the Fed to bring rates down to what they assume is a more ‘neutral’ level even if it then has to hike rates in later years.