Artemis Strategic Bond quarterly review, December 2023

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

Fund objective 

To provide a combination of income and capital growth over a five-year period. 

About the fund

The Artemis Strategic Bond Fund provides investors with exposure to a blend of different types of bonds. The managers dynamically manage this blend, shifting between different areas of the bond market in response to changes in the economy and financial markets.  It invests in three broad types of bond: 

Government bonds – These are widely viewed as being among the safest type of bond. The interest rate, or ‘yield’, available here is usually quite low but it has risen significantly over the past two years as investors began to anticipate that interest rates would need to move higher. This pushed their prices lower (bond prices fall when yields rise and vice versa). 

Investment-grade corporate bonds – These are issued by companies with higher credit ratings. These are businesses that independent agencies (such as S&P and Moody’s) consider to be at relatively low risk of defaulting on their debts. They tend to offer a higher yield (rate of interest) than government bonds and changes in this additional yield (the ‘spread’) reflect investors’ changing views on the economy.  

High-yield bonds – These are issued by companies that ratings agencies regard as being at greater risk of defaulting on their debts and which therefor offer a higher yield to compensate for the higher level of risk. Their returns are influenced by investors’ appetite for risk and their views on the economy.  

Performance

For full five-year discrete performance, please see the table below. Please remember that past performance is not a guide to the future.

The rally seen across bond markets in the final quarter of 2023 was swift and significant. The fund returned 7.9% during the quarter, ahead of the 7.0% average return from its peer group, the Investment Association’s Sterling Strategic Bond sector, which acts as a ‘comparator benchmark’ against which the fund’s performance can be compared.

It is unusual to see such sharp movements in bond markets. So what happened? The main reason for the sharp rally was a shift in tone – and in guidance – from the US central bank, the Federal Reserve, which sets interest rates for the world’s largest economy. As inflation eased, the Fed signalled that it was done pushing interest rates higher and that it would likely start cutting interest rates in 2024. From the perspective of the bond market, which tends to thrive when interest rates are falling more quickly than expected, this change in tone was welcome news.

Changes to the fund

A new addition to the team

This quarter saw Liam O’Donnell joining Artemis to take the lead on the government bond elements of Artemis’ bond funds. Liam managed government bond funds at SLI/Aberdeen and was also a co-manager of their strategic bond fund for over five years. Following his appointment, management of the Artemis Strategic Bond Fund is now divided between three fixed-income specialists:

• Liam O’Donnell (government bonds).
• Grace Le (investment-grade corporate bonds).
• David Ennett (high-yield bonds).

Government bonds (19% of the fund)

Through late summer and into the autumn, we began to position the fund to reflect our expectation that interest rates had peaked. As part of this, we sought to take advantage of volatile market conditions in October to increase its potential to profit from a fall in interest rates (in technical terms, we increased the fund’s duration). As a result, our allocation to bonds issued by governments in the UK, the US and New Zealand increased. The fund then enjoyed strong returns from these holdings as bond markets rallied sharply through the final two months of 2023.

Given the scale of the move higher in bond prices we saw in December, it seemed prudent to book some profits going into the end of the year. So, in the final week of 2023, we reduced its exposure to government bonds. As the year ended, 19% of the fund was invested in government bonds.

Investment-grade bonds (56% of the fund)

We continued to position the fund towards the higher-quality end of the investment-grade bond market.

Through October, we saw an increase in yields on longer-dated bonds (those due to return capital to investors in more than five years’ time) relative to their shorter-dated equivalents (those due to mature within the next five years or sooner). We took the opportunity to move from shorter-dated to longer-dated bonds from issuers such as Deutsche Bank and Blackstone Property.

We switched from a euro-denominated Ford bond to one of its sterling-denominated issues, following outperformance by the former. (The car marker’s bonds were upgraded to investment grade by ratings agency S&P during the quarter.)

We were also busy moving between different bonds from the same issuer in order to seek the best blend of yield and security. For example, we moved from a riskier (subordinated) bond issued by Barclays into one of its less risky (more senior) bonds. The result was that we lowered risk for only a modest sacrifice in yield.

High yield (22% of the fund)

Our allocation to high-yield bonds is currently low by the historic standards of this fund. We do, however, think the short-dated, higher-quality end of the high-yield credit market is extremely compelling. Our holdings here are overwhelmingly BB-rated bonds along with some B-rated bonds (these are bonds ratings agencies such as S&P and Fitch believe to be less risk of default than lower quality CCC-rated bonds).

These holdings include bonds issued by Allwyn, the operator of several national lottery systems in the US and Europe (including the UK following its recent purchase of Camelot). We like the high margins and predictable earnings of lottery operators, as opposed to casino or other forms of gaming.

Elsewhere, we took small positions in:

• UK homebuilder Miller Homes;
• Battery maker Energizer; and

• Global beverage can maker Ardagh Metal Packaging.

On the sales side, we sold our position in North Sea energy producer Ithaca Energy after a strong period of performance. We are mindful of mounting regulatory uncertainty around North Sea operators. We also sold our holding in information storage provider Iron Mountain.

Outlook

It is hard to overstate the significance of the change in stance by the US central bank towards the end of last year: it represented a seismic shift. The threat that interest rates might continue to move higher meant sentiment towards the bond market had been extremely negative for two years. By signalling that it would start to cut interest rates in 2024, the Federal Reserve instantly strengthened the case for owning bonds in the US.

In the UK, the Bank of England is attempting to temper market expectations that it will cut interest rates in the near term – but investors are paying little heed. In part, that is because recent data have called into question the belief that inflation in the UK will prove to be ‘sticky’. The market’s interpretation (and it is one we tend to share) is that the Bank of England will be forced to stage a sharp retreat from its pledge to keep interest rates at current levels “for an extended period of time”.

Clearly, after the powerful rally in bond markets seen in December, their prices are less attractive than they were three months ago. We do not have any particular conviction that the US central bank will cut interest rates by more than the market currently expects. Nor do we envisage a sharp recession, or a significant ‘risk off’ event which might cause investors to seek safety in government bonds. Instead, we anticipate an environment of muted but positive economic growth in which a combination of lower inflation and a gentle decline in interest rates provide powerful tailwinds for returns from bond markets.

Risks specific to this fund

Market volatility risk

The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.

THIS IS A MARKETING COMMUNICATION. BEFORE MAKING ANY FINAL INVESTMENT DECISIONS, REFER TO THE FUND PROSPECTUS, AVAILABLE IN ENGLISH, AND KIID/KID, AVAILABLE IN ENGLISH AND IN YOUR LOCAL LANGUAGE DEPENDING ON LOCAL COUNTRY REGISTRATION, FROM WWW.ARTEMISFUNDS.COM OR WWW.FUNDINFO.COM.

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