Artemis High Income Fund update

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

• The Artemis High Income Fund delivered a total return of 1.6% over the quarter, versus 0.9% from its peer group.
• The fund was the top performer in its peer group over the first half of 2024. 
• We positioned the fund in anticipation of a volatile summer for bond markets. 

The Artemis High Income Fund’s objective is to provide a combination of a high level of income and capital growth, before fees, over a rolling five-year period. The managers define a high level of income as equal to, or in excess of, the average yield of the funds in the Investment Association sector, the Strategic Bond sector. The fund is actively managed. 

In searching for attractive sources of income, the majority of the fund is invested in bonds – particularly high-yield bonds – but it also has the capacity to invest in company shares:

• High-yield bonds – Holdings in high-yield bonds are at the heart of this fund. These are issued by companies that ratings agencies (such as S&P and Moody’s) deem to be at greater risk of defaulting on their debts. As their name suggests, they offer a higher ‘yield’ (rate of interest) to compensate for the higher level of risk.
• Investment-grade corporate bonds – These are issued by companies with higher credit ratings. These are businesses that ratings agencies consider to be at relatively low risk of defaulting on their debts.
• Government bonds – These are widely viewed as being among the safest bonds (governments in developed economies rarely default on their debts). The interest rate, or ‘yield’, available here is lower than it is on high-yield and investment-grade corporate bonds – but they can provide a useful counterweight to the fund’s holdings in more economically sensitive bonds and shares.
• Dividend-paying equities – These are shares in companies that return a portion of their profits to their shareholders through regular cash payments (‘dividends’).

Performance

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

Over a choppy quarter for bond markets, our strategy of investing in income-producing assets with a relatively low sensitivity to changes in interest rates continued to serve the fund well. It delivered a return of 1.6% over the quarter, versus an average return of 0.4% from its benchmark, the IA’s Strategic Bond sector.  That capped off a good start to 2024: a total return of 5.2% over the first six months of the year made the fund the best performing fund in its peer group¹.   

More significantly, as the table shows, the fund’s commitment to delivering a high level of income has resulted in a significant margin of outperformance relative to its benchmark over the long term.  

Review

Some of the biggest contributions to the fund’s positive return over the quarter came from its holdings in the high-yield market, with the biggest contributions coming from:

• Heimstaden (European real estate),
• Pfleiderer (construction materials), and
• Victoria (carpets).

We also saw useful contributions to returns from the equity portion of the portfolio, notably from our holdings in 3i and in UK banks Barclays and NatWest.

The fund’s relative lack of exposure to longer-dated government bonds (those not due to be repaid for 10 years or longer) also helped its returns relative to some of its peers. ‘Stickiness’ in inflation, uncertainty about the timing and extent of interest-rate cuts, worries about government debts and political flux resulted in a difficult and volatile quarter for the major government bond markets. Longer-dated bonds are particularly sensitive to changes in investors’ expectations around interest rates.

Inevitably, not every holding outperformed. On the negative side, the fund’s underperformers over the quarter included:

• Medical Properties Trust, a real estate company that owns hospitals and healthcare facilities in the US (bonds);
• Melrose, aerospace (shares); and
• Sotheby’s, the auction house (bonds).

Changes to the fund

We bought a number of newly issued bonds over the quarter. They included:

• Herc Rentals, a US equipment rental firm;
• BlueNord, a Danish oil & gas producer; and
• MasterBrand, the market leader in household cabinetry in the US.

We also bought newly issued bonds from Bertrand Franchise, a French business which owns the master franchise agreement for Burger King in France. We have lent to the Burger King France business before and have seen it deliver excellent operational performance and growth. We believe that it has attractive longer-term growth prospects.

In the secondary market…

We added a position in Isabel Marant, a French fashion label. Like much of its sector, it has struggled amid a weakening in consumer confidence, but we believe its core brand remains intact.

We added positions in two cruise operators: TUI and Carnival. We believe both companies have strong market positions and will benefit from consumers’ ongoing preference for spending on experiences over physical goods. Both companies have begun taking steps designed to improve their credit quality.

We continued to find compelling opportunities among short-dated high-yield bonds…

To recap, shorter-dated high-yield bonds (those due to be repaid in five years or less) tend to be less volatile than the broader high-yield market. They also have a tendency to be redeemed early, creating capital gains for their holders.

One of the companies we use to demonstrate this opportunity is Perenti, an Australian mining contractor. It partially redeemed its short-dated bonds during the quarter at a premium i.e. it paid us extra to redeem them ahead of schedule.

This quarter, we added short-dated bonds of IMA – an Italian producer of specialist packaging machinery for pharmaceutical, dairy, and other consumer goods – to the portfolio.

On the sale side of the ledger…

We sold a number of bonds that had performed strongly and which, in our view, offered little further prospect of further outperformance. These included:

• La Doria, a manufacturer of canned and bottled foods, whose bonds we had bought at the time of issue earlier in the quarter;
• Consensus Cloud, a provider of online fax solutions;
• Teva, the global generic pharmaceuticals company;
• Legends Hospitality, an operator of sporting concessions;
• JB Poindexter, a truck parts manufacturer;
• Veritext, a legal services firm; and
• Dufry, the operator of duty-free stores.

We still like these companies fundamentally and may invest in their bonds again if or when their relative valuations become more compelling.

Outlook

Over the summer, investors tend to head to the beach and away from their Bloomberg screens. As a result, there is less trading in financial markets, and we often see market moves – particularly in government bonds – being amplified by lower levels of liquidity; I see little reason to think that this year will buck the trend. This year, the summer holidays coincide with an unusually intense political environment, and they arrive just as concerns about the long-term sustainability of government debts are increasing. So, this is not a time to be bold. Happily, the levels of income on offer in the high-yield market mean we don’t need to take outsized risks to generate meaningful returns.