21 Apr 2020
Last week the Fed announced its $2.3 trillion package to support the US economy during the crisis. In this article, James Foster and Alex Ralph, managers of the Artemis Strategic Bond Fund and the Artemis High Income Fund, discuss what the Fed’s new measures mean for bond markets and how they have positioned their portfolios.
The last week has been much quieter with the Easter break acting as a substantial relief for markets. Having said that, it has also been a very positive week with the Fed announcing new measures to help support the more distressed parts of the bond markets: in particular, a package of support for the ‘fallen angels’. Those are bonds on the cusp of high yield which have struggled to raise new finance given the prospect of downgrade and then been cut off from support via quantitative easing. Investment grade companies are normally the only companies featuring in quantitative easing programmes. Dollar corporate debt was under stress due to the quantum of companies that were either on the precipice of being downgraded into high yield or had already been. This alleviates much of that stress.
Secondly, we have also seen support for the high yield market with purchase programmes for high yield Exchange Traded Funds. Initially in small size, it is however the first time a central bank has committed to buying high yield, a bold step. There is many a debate to be had over the long term implications of such moves, but in the short term it created a huge rally within credit, particularly high yield.
We will argue another day about the moral hazard this creates. Why bother with credit analysis if any company, good or bad, will be supported by the Fed? But these are extraordinary times needing extreme measures. The difficulty will be when the next “normal” recession occurs – will the Fed let bad companies fail then? They should, otherwise you lead to more zombie companies and inefficiency - but that demonstrates the conflict between a purist economist and a politician seeing re-election.
We have continued to reduce our government bond positions as we continue to invest in new investment grade and even some high yield positions. Our government bond holdings, as a reminder, peaked at around 43%, and is now down to 30%. We have been selling these in favour of investment grade positions. Our high yield bond percentage is 28%, with the balance of 40% of the portfolio in investment grade bonds and a small amount of cash.
Our duration has shifted a little longer, as we are investing in more new issues with a 10-year maturity, financed by selling shorter dated gilts. It is now 5.2 years. This feels no bad thing. Markets seem to be assuming a V-shaped recession whereas we believe a U- shaped is more likely.
The latest short term economic forecasts have been unbelievably awful. Hopefully the economy will recover quickly once lock-down measures are lifted, but until we get a widespread vaccine, it is difficult to see everything returning to normal instantaneously. Therefore, our belief is that optimism about an instant recovery feels misplaced. That should be supportive for government bonds - for now. However, we will remain alert as yield curves are likely to get steeper as the full horrors of the funding for all of the government measures start to be understood.
We continue to believe that adding to high yield positions, whose top line should be able to weather the storm, is the correct decision. Those companies are in much demand however, and the market is now needing the new issue market to open to satisfy demand, a true indicator that central bank intervention has worked.
The extreme volatility in the equity market is calming down a bit - but is still at levels which would dissuade us from adding back materially to our equity weighting. For now, as mentioned, there are better and more imminent opportunities in the high yield space, closer to the levers of central banks’ support. However, we still have work to do in the existing equity allocation in order to make sure we achieve two things. These are to preserve the income element of the equity portfolio; and to make sure we do not end up with an unintended cluster of risk while doing so. This means taking prompt action to reallocate funds away from companies which have either cut their dividends or postponed them - but with no future date specified. In reinvesting this capital we have to try our best to ensure that we are not buying into a situation where the dividend is unsafe for any currently identifiable reason.
We are also not chasing unusually high yields to try to make up any deficit. This may signal that the market believes the pay-out is not secure. So instead we are looking for holdings which have a reasonable yet defensible level of income on offer. Fortunately we have the whole of Europe and the UK to search for these stocks. In recognition of the fact that the UK is becoming a more difficult market in which to source dividends, we have made a tactical reallocation to overweight the European equities for the time being. As a consequence the European segment is around 60% of the equity holdings and the UK segment around 40%. Our policy of only holding appropriate sizes of position in liquid equities has made this transition straightforward. The net result of this recent activity is an equity component of the portfolio with an average yield of just over 5.5%. That we believe is attractive, but not greedy.
To find out more about the Artemis Strategic Bond Fund and Artemis High Income Fund and their positioning visit the fund pages at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The funds are an authorised unit trust scheme. For further information, visit www.artemisfunds.com/unittrusts.
Third parties (including FTSE and Morningstar) whose data may be included in this document do not accept any liability for errors or omissions. For information, visit www.artemisfunds.com/third-party-data.
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.
Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.