Artemis Strategic Bond Fund update

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

The Artemis Strategic Bond Fund’s objective is to provide a combination of income and capital growth over a five-year period.

• The fund returned 4.3% over the quarter versus an average return of 3.7% from its benchmark, the IA Sterling Strategic Bond sector NR¹. 
• Many of the world’s central banks are responding to slowing economic growth and lower inflation by cutting interest rates, which should be supportive for bonds.
• Although we are positive on the prospects for the bond market, growing government deficits and political populism mean we remain cautious towards longer-dated government bonds.

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 fund returned 4.3% over the quarter, ahead of the average return of 3.7% from its benchmark, the IA Sterling Strategic Bond NR sector. Over the year to date, meanwhile, it has returned 6.3% versus an average return of 5.0% from its sector.  

Over the quarter, some of the biggest contributions came from the fund’s holdings in bonds of three real estate companies:

• Heimstaden (a Swedish residential real estate business)
• CPI Property (a Czech residential real estate company)
• MPT (which owns and leases healthcare facilities worldwide).

We retain a positive view of the outlook for the real estate sector, which is a direct beneficiary of lower interest rates. 

The biggest negative, meanwhile, came from the fund’s holding in an investment-grade bond from Southern Water. Returns across the water sector over the quarter were weak. To help attract investors, newly issued bonds from Welsh Water, Anglian Water and Yorkshire Water were offered at a discount and so weighed on bond prices across the sector.

Overview

It was a broadly positive quarter for bond markets. In part, that was thanks to central banks, which responded to easing inflationary pressures and slowing economic growth by cutting interest rates. The Bank of England kicked things off in August with a five-to-four knife-edge vote to lower interest rates from 5.25% to 5%.  Sweden’s Riksbank, the Reserve Bank of New Zealand and the Bank of Canada followed suit.  

Yet while the overall direction of travel was positive, there were periods of elevated volatility. A weak report on the US jobs market in early August showed a surprise jump in the unemployment rate. In some quarters, the interpretation was that the US economy was already in recession. The market’s reaction suggested that the US central bank, the Federal Reserve, had made an error in not cutting rates sooner. 

A brief period of turmoil resulted, with wild swings in bond yields, share prices and currency markets. The volatility was exacerbated by low levels of trading due to the summer holidays and by the Bank of Japan’s decision to raise interest rates, which came as a mild surprise to the market. 

In September, the Federal Reserve assuaged fears of a slowdown by making a bold cut to interest rates.  That eased the market’s worries while also hinting at the possibility of more aggressive interest rate cuts in the months ahead.

So, while it was a positive quarter – and we remain optimistic 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.  

Activity

• Government bonds (20% of the fund)

Issued by governments, these are widely viewed as being among the safest type of bond. Because high interest rates provide alternative way of earning returns with low risk, government bonds tend to become more attractive when interest rates fall. For this reason, interest rates and bond prices tend to have an inverse relationship.

Throughout the quarter, we remained positive on the prospects for government bonds due to the simple fact that interest rates in most of the world are moving lower. So, over a busy-but-volatile period, our strategy was to express a positive view on bonds while also making on-the-fly adjustments to the fund’s sensitivity to changes in interest rates. Throughout the quarter, as investor sentiment fluctuated and as bond prices either over- or under-reacted to news on inflation, elections, the jobs market or statements from central bankers, we added to (or subtracted from) the fund’s positions in government bond markets worldwide. 

In July, for example, we increased the fund’s capacity to profit from cuts in interest rates. The catalyst for doing this in Europe was the significant movement in bond prices ahead of elections in France. We also added exposure to Australian bonds, which had lagged returns from other bond markets significantly as some analysts called for the Reserve Bank of Australia to raise interest rates in response to higher inflation. Our view was that rate hikes in Australia were less likely than the market believed. 

In August, with the UK government bond market having underperformed some of its global peers, we shifted some of the fund’s exposure to the Australian bond market back to the UK. 

In September, the US’s central bank, the Federal Reserve, cut interest rates by half a percentage point. We adjusted the portfolio to express a less negative view on the prospects for Japanese government bonds. Elsewhere, we sold French government bonds. The country’s deficit is coming under closer scrutiny and its deficit-reduction goals look out of reach for its fragile government.

• Investment-grade bonds (48% of the fund)

These are issued by companies 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 slightly higher yield (rate of interest) than government bonds.

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. 

Barclays – Within the UK bank sector, we sold out of Barclays and used 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 these two banks, whose bonds were not as attractively valued as they once were. 

BNP and BFCM – questions about the French government’s untameable budget deficits are growing louder, so we sold the fund’s holdings in bonds issued by French banks, which would be exposed were there to be a sell-off in French government bonds.

• High-yield bonds (28% of the fund)

These are issued by companies who ratings agencies regard as being at greater risk of defaulting on their debts and which therefore offer a higher yield to compensate for that risk. Their returns are influenced by movements in the underlying yields on government bonds and by changes in investors’ appetite for risk and their views on the economy.

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 this UK housebuilder, whose focus on affordable housing aligns it with the goals of the new government.

Azelis – We bought bonds from European specialty chemical manufacturer Azelis whose 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. 

Center Parcs – This holiday resort’s impressive ability to push up prices may finally be at its limit.

Ocado – We sold our position in food-delivery and technology company Ocado following a successful refinancing operation. Although we still believe in its mission to become a high-margin, high-cashflow technology services company, this is now reflected in the price of its bonds. 

Outlook

Today, the inflation picture in the US is admittedly rather muddy. The path globally, however, is still towards lower rates. We would caution against reading across too much from (volatile) economic data in the US to the prospects for interest rates worldwide. Even if the US central bank were to move more hesitantly in lowering interest rates than was expected a few weeks ago, it would not negate the powerful effect of lower interest rates in other economies. 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 slowing economic growth as a greater risk than inflation. Japan is the only clear outlier.

All else being equal, lower interest rates should be good news for bonds of almost every variety. Within that, we believe the argument for investing in short-dated investment grade bonds is particularly compelling.