David Ennett and Jack Holmes, managers of Artemis Funds (Lux) – Short-Dated Global High Yield Bond, report on the fund over the quarter to 31 December 2024 and their views on the outlook.
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. CAPITAL AT RISK. All financial investments involve taking risk and the value of your investment may go down as well as up. This means your investment is not guaranteed and you may not get back as much as you put in. Any income from the investment is also likely to vary and cannot be guaranteed.
Objective
The fund is actively managed. It aims to generate a return greater than the benchmark, after the deduction of costs and charges, over rolling three-year periods, through a combination of income and capital growth.
Performance
The Artemis Funds (Lux) – Short-Dated Global High Yield Bond Fund made 1.8% during the fourth quarter, compared with gains of 1.2% from its Secured Overnight Financing Rate (SOFR) benchmark.
Over the full year, it was the best performing fund of the 22 in its short-dated high-yield peer group. As our outperformance in December demonstrated, this was not simply derived from holding more risk in a rising market. Instead, the key drivers have been strong credit underwriting – in other words, avoiding the blow-ups – and large gains from a couple of individual positions.
Positives
Our holdings in the real estate sector were a notable highlight. Swedish residential landlord Heimstaden AB rallied on news its operating company was accessing public debt markets, while investors in CPI, the central European real estate company, benefited from continued investor comfort with the sector as it continued to deleverage. Spanish homebuilder Neinor Homes also did well as Spain continues to be a bright spot within Europe.
Recent purchase TI Fluid Systems, a specialist auto-parts manufacturer, hit the ground running. We have started to add risk back in the auto sector in recent months as valuations have become cheaper. TI has an attractive niche in pressurised fuel tanks which stand to disproportionately benefit from what we think will be a slowdown in the sale of battery electric cars and a corresponding increase in mezzanine technologies, such as full and partial hybrids.
Constellation Automotive, the UK market leader in dealer-to-dealer used car sales via its BCA brand, received a significant equity contribution from its sponsor and at the same time communicated its refinancing plans to investors. These led to a significant rally in its bonds, of which we are significant holders. This outcome was pleasing as it reinforced one of our core philosophies – if, by concentrating on the strength of a business model, we can identify a company that can structurally generate profit and create value for its shareholders, it is likely to find the resources needed to survive lean periods of cyclical demand. Constellation has a dominant market position and is a key part of the automotive ecosystem. While the cycle is struggling, the core value proposition of the company remains compelling and, in our view, valuations reflected short-term fears over long-term value creation.
IHO Verwaltungs, the holding company of Tier-1 German auto parts manufacturers Schaeffler and Continental, performed strongly after the market’s perception of the correct risk premium moved closer to our own. Again, cyclical pricing looked overdone, and we were able to profit from the market unwinding some of its overblown concerns.
Negatives
Our holding in German pharmaceutical Cheplapharm suffered following a disappointing set of Q3 results. While these were below our expectations, the underperformance of the bonds looks overdone to us now.
US medical real estate investment trust Medical Properties Trust saw continued underperformance of its largest client, which led us to become more cautious on its ability to manage upcoming 2026 maturities. We sold out.
French fashion house Isabel Marant underwhelmed the market with a cautious outlook for the remainder of the year, while LGI Homes was a touch softer as the US mortgage market reacted to the changing outlook for interest rates.
Purchases
One notable purchase over the quarter was Belron, the global leader in windscreen-repair, operating in North America, Europe and Australasia. It is known through its Autoglass brand in the UK. Windscreen repair is hugely profitable, especially to market leaders with the largest fleets. In addition, the increasing use of sensors located just behind windscreens means minor repairs now require specialised equipment to recalibrate said sensors, which acts to both increase pricing and drive out smaller competitors unwilling to invest. As the market leader, Belron is set to capture the natural consolidation in the industry.
A new issue from European high-yield stalwart Techem also warrants a mention. Techem provides energy-metering services in Germany and surrounding countries. What is interesting is that while the purchase multiple of 12x run-rate EBITDA is unchanged from 2018 (when the business was last sold), the amount of leverage loaded onto the business is not. At the time of the 2018 transaction, the new equity owners funded the 12x figure with 7.3x of debt, with the balance (4.7x) funded by cash equity. This time, the leverage is more restrained at only 5.8x. This underlines a prominent theme in high yield where companies are responding to more expensive debt (higher yields) by having less of it. This suits us as we are being asked to accept less credit (default) risk and are being paid more for it. The price of this is likely to be depressed future returns for infrastructure/private equity funds as they are forced to make larger cash equity contributions to get deals done.
We bought the bonds of one of the highest-quality businesses in high yield, bookmaker IGT. At least one agency recently reclassified the company as investment grade and we believe it will receive further upgrades in the months to come. As it moves into the investment grade indices, spreads should tighten as a new larger and less price-sensitive buyer base steps in.
November addition Asmodee, a producer of table-top board and card games, got off to a strong start. We like the company’s diversified portfolio of strong brands, good earnings momentum and the potential for a significant deleveraging transaction in six months’ time that didn’t look to us to be in the price we bought it at.
Sales
On the sales side, we exited our position in European lottery provider Allwyn. The bonds have performed well and while there is still much to admire in the core European business, we are growing concerned about the faltering performance of the recently acquired UK lottery business. We will likely re-engage with the company, but for the time being the valuation is a little rich for the possible threats to earnings. We also exited wheelchair maker Sunrise Medical, primarily on valuation grounds.
Other bonds we sold included Multiversity, an Italian online university, and Bertrand Franchise, a French restaurant group which owns the rights to Burger King in France. Nothing extraordinary has happened in either of these businesses since we invested in them. The point is that just because these kinds of issuers are not in the group of over-covered index constituents towards the larger end of the high-yield market, they are often structurally mispriced and able to generate alpha even if the macro is going against them.
Outlook
2024 was supposed to be a year in which interest rates were cut, government bonds rallied and high-yield spreads widened. While the first of these three trends materialised, the latter two did not. Yields on 10-year US Treasuries, German bunds and UK gilts are all higher now than they were at the beginning of 2024. High-yield spreads are almost 100bps tighter, rather than wider. In other words, the consensus coming into 2024 – a weaker global economy and stronger government bond performance – has not played out.
So what will 2025 hold? While we are not macro investors, there are three good reasons to believe this year will look similar to the last one from the perspective of high-yield spreads.
- Fundamentals: Net leverage remains low and interest cover high. Economic performance, particularly in the US, remains robust. And with yields elevated, issuers are incentivised to pay off debt rather than increase it.
- Valuation: Although spreads are tight, they can remain so for extended periods, as they did in the mid to late 1990s and mid-2000s. And tight spreads matter a lot less when yields are high – even if they widen, the starting carry can soften the blow of any volatility. Remember, yields drive returns, not spreads – and these look healthy.
- Technicals: The increasing demand and falling supply of high-yield bonds create a strong backdrop for the asset class.
The two main risks to the bull case are at opposite ends of the spectrum – either a significant downturn in the economy will cause concern about corporate fundamentals, or a combination of stronger economic performance and worries about stubborn inflation will cause central banks (notably the Federal Reserve) to stop cutting. In the former scenario, strong underlying fundamentals and higher starting yields will soften any blow. In the latter scenario, we think high yield is probably reasonably well insulated due to its lower duration and higher levels of carry.
In short, there are good reasons to believe spreads will remain tight in 2025 and a combination of robust fundamentals and a strong technical backdrop will drive another year of strong performance. However, given the potential for a surprise to the downside (and reasonably tight spreads) we believe focusing on the front end, driving high levels of carry and exploiting single-name opportunities as and when they present themselves provide much better risk/reward opportunities in the year ahead.
