*Fund risk profiled by Distribution Technology as a 5.
In association with
WELCOME
This edition of Focus looks at the Artemis High Income Fund, a vehicle that invests in both bonds and high-yielding equities in order to provide a good level of income in today’s challenging market environment. Fund manager Alex Ralph reveals in this eBook the research-based approach she uses to put together a diversified portfolio that aims to deliver a higher than average income, while maintaining a low-to-medium risk profile*. Ralph also provides her view on investor concerns regarding liquidity in the bond market, and explains how she is managing the geopolitical volatility that is impacting UK and global markets today.
Alex Ralph, manager of the Artemis High Income Fund, on balancing risk and reward to generate above average levels of income
*Artemis As at 30 June 2017. ** FE/Artemis As at 30 June 2017.
Sector breakdown
After the longest bull market in history, bond markets have been challenged by a number of political and economic surprises. In response, at times the market has been very volatile (and yet has held up). As a result, investors may feel the ability of bond managers to maintain or even increase income is now unrealistic.
Ralph maintains a low turnover on the fund, in spite of recent volatility. This is in part a result of the market remaining expensive. “We are in an environment where it is very difficult for me to suggest anything other than the fact that it is quite expensive. Will it stay expensive? Yes. There are so many factors in play that we think credit will stay broadly expensive,” she explains. Nevertheless, Ralph argues that pockets of value do exist; and the fact her fund is focused on income, rather than on capital growth, should mean it is more likely to succeed. “In the current environment, which has shown itself to be not particularly good for investing in credit for capital growth, the best option may be to invest in a fund that at least provides a higher level of income - and also tries to protect your capital at the same time,” she says.
Challenging markets
She does have several sectoral biases in play currently, including financials, which accounts for just over 40% of the portfolio. Ralph describes the sector as offering high levels of income relative to risk. However, she admits the fixed income market remains challenging. “Markets are changing and companies are coming in and re-financing at cheaper rates. Take Center Parcs, for example. A few years ago it was not very well received because most investors did not know or understand the company. But we researched it, and bought it at issue with an 11% coupon. It re-financed four years ago at 7% - a reflection of the fact that people trusted the brand more. It recently re-financed again at an 8% coupon. And that is purely because the market has changed.”
Sector bias
The fund sits in the Investment Association Sterling Strategic Bond sector. It is known to position itself more aggressively than traditional strategic bond funds however, with just over half of the portfolio invested in sub-investment grade debt. Alongside this, up to 20% of the portfolio is invested in equities. Together, these assets assist in delivering the high income the fund aims to provide to investors.
Yet there are some fixed income funds providing a higher level of yield that is proving sustainable, and is offered alongside the aim of some capital growth. The Artemis High Income Fund is one such fund. The £1.2 billion* fund invests predominantly in fixed income, but has the ability to invest up to 20% of its assets in higher-yielding equities. It does so in order to achieve an ‘above-average’ level of income, alongside the prospect of some long-term capital growth. The fund, managed by Alex Ralph, has returned 15% over three years ahead of the IA Sterling Strategic Bond sector average of 12%**. It is also first or second quartile over one, three and five years. The fund does not adhere to an external benchmark, but returns are significantly ahead of key UK indicators including CPI and RPI at 3% and 6% respectively** over the same period.
“There is no actual measure or way that we define an ‘above-average’ level of income” explains Ralph. “Without taking on too much risk, we want to generate a high level of income. Getting that balance right is crucial.” The firm employs a collegiate approach when researching ideas. Artemis’ fixed income and equity teams sit side-by-side and discuss ideas on a continual and day-to-day basis. As the fund’s manager, Ralph has overall responsibility for portfolio selection. To select equities for the fund, Ralph works closely with Artemis’ UK equity income team, led by Adrian Frost. The manager looks ‘through’ market risks and economic cycles, rather than increasing or decreasing risk for different types of market environments. Ralph’s fixed income strategy focuses on finding companies where the risk is mispriced, in particular where risks have been under- or over-estimated in her view. Ralph also looks for companies that she believes could de-lever through growth or cashflow generation in the coming years. As the fund is set up to perform through economic cycles, it is more likely to experience short periods of underperformance relative to traditional strategic bond funds.
Ralph explains: “When credit risk widens, as it did during the financial crisis in 2008 and the European crisis in 2011, there will be periods of volatility and/or underperformance. “But our job is to make sure we take advantage of that volatility and make a call on when to increase the credit risk.” Cashflow analysis, creditworthiness and bond pricing are used to identify which assets to include in the fund, with Ralph noting the research of an issue is very much about “drilling into the numbers” and determining a bond’s relative value. However, the fund has little restriction in terms of the types of companies it can invest in, and Ralph never discounts any issues.
Investment philosophy
THE INTERVIEW
Finding the right balance between income and risk is key to Artemis High Income
Alex Ralph,
Artemis Fund Managers
Source: Allianz Global Investors. As at 1 April 2017
FUND OUTLOOK
How has the Artemis High Income Fund performed?
Negative/positive periods over past five years
Artemis High Income performance versus peer group (%)
Artemis High Income: Future outlook
Artemis High Income: Performance
In addition, the fund has seen less negative periods over the past five years than the sector average, outperforming 73% of the time versus peers. As at 30 June 2017, the fund had a distribution yield of 5.4%*.
The Artemis High Income Fund does not adhere to any specific benchmarks but instead focuses on achieving an ‘above average’ and relatively high level of income by investing in bonds and some higher yielding equities too. Since Artemis Fund Managers acquired the strategy, the fund has achieved a return of 193.2% significantly outperforming the IA £ Strategic Bond sector average of 111.4% over the same period. The fund is also first quartile over one and five years.
Regardless of the political challenges across Europe and in the US, underlying global data still seems, in aggregate at least, sanguine. This has provided some support to strengthening global equity prices during the seasonal summer lull. Looking at bond markets, stalling inflationary pressure, dollar weakening and softening oil prices, have provided the asset class with some short-term relief and resulted in depressed markets such as emerging market debt rallying. That said, there is noted caution looking further ahead. Firstly, consensus towards further rate rises by the Federal Reserve has grown. Meanwhile, the UK’s Monetary Policy Committee seems to be near a tipping point. Aside from Brexit, there are returning concerns around Greece and the fragile European banking sector, with recent European Central Bank led rescue deals for Italian and Spanish banks. Both issues have yet to impact wider markets while appetite for riskier high yield assets remain strong. This has been recently illustrated in the market by Argentina issuing an unprecedented 100 year bond at 8% in June. With so many factors in play and with the potential to impact investment markets, PureGroup has analysed a range of macro indicators to understand how they could impact the Artemis High Income Fund in the coming months.
Peer group average
Artemis High Income
26.7%
negative
31.7%
68.3%
positive
73.3%
Source: FE, Artemis Investment Management. Since launch data from 9 September 2002 to 7 March 2008 reflects class R quarterly distribution units, and from 7 March 2008 to 30 June 2017 reflects class I quarterly distribution units, bid to bid in sterling. All figures show total returns with interest reinvested. Sector is IA £ Strategic Bond NR. *Negative/positive periods refer to monthly outperformance over five years as at 26 May 2017.
IA £ Strategic Bond
29.6
12.2
6.4
111.4
13.3
59.4
15.4
193.2
Peer group*
PureGroup analysis:
Bond exposure continues to be impacted by global interest rates and global inflation. As expected, the Artemis High Income Fund, with its majority exposure to fixed income is impacted by factors including global short-term interest rates and inflation increase. However, this impact has been muted as rates are still at historic lows and inflation, while returning, has been held in check by energy prices. Meanwhile, the fund itself is maintaining a current low duration as well.
Source: PureGroup As at 31 March 2017
Peer group AVG
Following sustained growth in US dollar strength against its major trading partners over the past five years, the currency has weakened in recent months. This downward movement in the currency will have been a positive for the fund which has a negative sensitivity to the USD trade weighted index.
*Peer Group comprised of all active and passive cautious mixed asset investment funds that are registered for sale in the UK. Arrows indicate movement of factor direction.
Strong corporate and investor confidence in markets remains. While global growth persists, we would expect both business and investor confidence to remain high. This business cycle would be a positive for the Artemis High Income Fund, as it has a negative sensitivity to both global default spreads and US volatility (a proxy for wider volatility).
Patrick Murphy is the founder of PureGroup, an independent company that works with management groups to provide them with a range of fund data, macroanalysis and insights that help to enhance client engagement.
The PureGroup Forward Perspective Model, has been built with leading US based academics, providing asset managers with macro-economic factor analysis to explain their position against the wider business cycle and against their peers.
Bond rating allocation
Because the fund is very much about getting the right level of yield for the credit risk we take on. In the financials space, investors can get a much better pick-up in yield than they can in other sectors. In Europe, we are quite optimistic on the economy overall compared to the market. So combined with the fact the fund is pretty short on duration, we are comfortable with the risk we are taking on through both the financials sector and the European consumer.
Just over 40% of the fund is invested in UK and European financials. Why?
Alex Ralph versus peer group (%)
How have you maintained the split between the bond element of the fund and equities?
We can invest up to 20% of the fund in equities. Currently, the figure is around 15%. The reason we have this equity allocation is for diversification. Also, especially in this kind of environment, the opportunity for capital growth from the bond portion of the fund will be scarce, so it is about balancing the two. The Artemis High Income Fund is a bond fund, nonetheless, and the strategy is based on the fact it looks to provide a bond income with an equity kicker. This is why the equity allocation does not go above 20%.
The fund has a lot of sub-investment grade debt. Are there any issues concerning liquidity?
Liquidity has been poor in the market although bizarrely, after Brexit, liquidity was probably the best it has been for a while. That period of stress after the event saw investors taking opposing views and it allowed stocks to trade. Currently, with many funds’ high cash levels and the fact we are looking at lower net new bond issuance than we have done for a while (as a result of the loan markets opening up again), liquidity has fallen again. Artemis has three fixed income funds with around £2.5bn in assets. This level is not too cumbersome and means we are able to trade easily in the market. But liquidity is definitely a factor. Where a company issue is only £200m for example, we would not participate in order to minimise risk.
How did you position the fund ahead of the General Election in June and what is your outlook for the UK market?
This is not our base case, but we do believe growth will be much slower in the UK than in Europe and the rest of the world. Real wage growth will ultimately fall, and even a soft Brexit will, we believe, cost the UK. So we are not particularly positive about the outlook for the UK.
Ahead of the General Election we took a (long) position in the US dollar. That’s because we thought markets were too sanguine in their expectation of a hung parliament. On the night of the election, at 10pm following the exit poll, we took a further dollar position. That now accounts for about 7% of the fund. We previously had (and still have) a short position in Treasuries. It is pretty small because we are not a strategic bond fund, so we are not trying to move strategically. But this position gives the fund a hedge against the periods of flux that we see ahead for the UK economy. In terms of the outlook for the UK, we are concerned. Inflation is taking off more in the UK than it is elsewhere, and the UK could enter a period of very low growth. If that continues, the country could even move to recession.
In Europe, we think they will start to taper QE at the end of Q4 this year. But unlike in the US in 2013, it has been pretty well flagged so it won’t be such a shock. We do foresee a rise in Bunds up until the year-end; and as a result we have kept duration short on the fund. But we are looking at the numbers coming out of Europe and believe the consumer is in a much better position relative to the UK. We think that will continue for at least the next six months; and as a result we are maintaining our exposure to the European consumer.
How are you positioning the fund in terms of Europe and quantitative easing?
'We do believe real wage growth in the UK will ultimately fall, and even a soft Brexit, will, we believe, cost the UK'
FUND Q&A
Artemis High Income Fund
Source: Artemis Investment Management As At 30 June 2017. Please note that figures may not add up to 100% due to rounding and the cash holding.
Source: FE. 1 July 2005 - 26 May 2017. Total Return performance in GBP.
Alex Ralph
Peer group composite
CONTACT US
Web: www.artemisfunds.com
Focus is an Incisive Media product. © 2017 Incisive Business Media (IP) Limited
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THIS INFORMATION IS FOR PROFESSIONAL ADVISERS ONLY and should not be relied upon by retail investors. The fund’s annual management charge is taken from capital. The fund may invest in fixed interest securities. The fund may invest in higher yielding bonds. The fund holds bonds which could prove difficult to sell. As a result, the fund may have to lower the selling price, sell other investments or forego more appealing investment opportunities. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any forward-looking statements are based on Artemis’ current expectations and projections and are subject to change without notice.
