06 Apr 2020
China continues to get back to work following the damaging effects of the Covid-19 pandemic. There is variation by industry in this resumption. Online businesses, software companies and infrastructure and industrial production are significantly better than service sectors, such as restaurants, hotels and tourism.
Our focus is shifting to the following:
On the first point, Chinese growth is likely to come under more pressure as Europe and the US are effectively shut down. Some of our Chinese companies have reported results or trading updates in the last week and we’ve been monitoring the corporate newsflow to try to identify any risks. Among our infrastructure-related holdings, there’s encouraging evidence of productivity resuming almost at full capacity. China Railway Group is one example. People’s Insurance Group of China (PICC Group) delivered results that were in line with the market’s expectations, but also increased their dividend payout ratio. There are some signs that the (much maligned) state-owned enterprises are doing much better than smaller and privately owned businesses in this environment.
In aggregate, the fiscal and monetary response in emerging-market economies has been small in comparison to what we’ve seen in developed markets (particularly the UK and the US). There remains potential for this to occur in emerging-market economies with many having reasonable headroom to increase both fiscal and monetary responses. China has significant potential here and has so far not delivered much, but is likely to in the weeks to come. In other markets, there is less potential for this and those with weaker economic fundamentals are more vulnerable. Brazil, South Africa and India are all examples.
When it comes to assessing the impact of policies to contain the virus spread there is much variation in approach in different countries. It will take some time (at least six to nine months) to understand whether the aggressive stance of lockdown leading to a complete halt in economic activity was the right approach to take. Brazil and others in Latin America appear to have taken limited measures to reduce the spread of the virus, whereas South Africa and India have been much more aggressive.
Clearly, the contrasting approaches mean selection remains crucial. Within the portfolio, we have increased our exposure to telecoms. SK Telecom (Korea), Globe Telecom (Philippines) and Turkcell are all examples here. Telecoms have proved to be a safe haven in the current situation. In addition, Korea has been an early adopter of 5G. Data usage in Philippines is lower than other markets in Asia and has potential to grow.
Raheel Altaf and Peter Saacke, Artemis Global Emerging Markets
To find out more about the Artemis Global Emerging Markets Fund and its positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The fund is a sub-fund of Artemis Investment Funds ICVC. For further information, visit www.artemisfunds.com/oeic. 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.
We expect economic data in the US to continue to deteriorate both for general economic activity and, as a result, unemployment. There is no doubt that the various plans put forward by the Federal Reserve and also Congress form quite a large safety-net supporting the smooth functioning of financial markets (witness the amount of investment-grade debt raised in the last week); as well as providing cash to the unemployed over the next number of months. There is no doubt that mathematically when businesses start opening up there will be a V-shaped recovery in economic growth. However we believe some participants imagine this will be a relatively rapid return to the levels of demand we saw last year. We are more cautious than that: the process of getting money from the Federal government to small businesses is far from straightforward; and as we have witnessed with new jobless claims, companies are reducing payroll - presumably in order to survive.
Because of this portfolios retain a somewhat defensive stance, underweight indebted companies and weaker business models and overweight greater levels of predictability and stability. We have not made significant changes in the past week.
All of that being said we are aware that as of today, and we believe over the next month or so, value stocks have become very cheap relative to the rest of the market. At this point we do not believe the conditions are there to make a decisive rotation to value as the cheaper stocks also tend to have more economic sensitivity and more indebtedness. But being stock-pickers, we have found some gems within the value group of companies. At the moment some of those are in technology which we believe will increase further. At this point it is not yet in financials - though we would imagine in the next number of months we will increase our financials weighting.
Cormac Weldon, Artemis US Smaller Companies and US Select
To find out more about the Artemis US Smaller Companies Fund and Artemis US Select Fund and their positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The fund is a sub-fund of Artemis Investment Funds ICVC. For further information, visit www.artemisfunds.com/oeic. 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.
We have had updates from almost all the companies held in the portfolio.
Common themes emerging:
Support from the UK government (most notably a commitment to cover 80% of labour costs for furloughed workers). The government has also encouraged all public sector bodies to pay their suppliers – even if those suppliers are not currently able to deliver a normal service (e.g. Mears.)
We’ve had many calls with companies over the last two weeks to get an updated view on monthly cash burn and how long they can survive a ‘lock-down’ before needing further funding. We are mindful that we need to keep some cash in hand in order to meet equity raises from companies we want to back.
Raising cash: both to fund the £24m outflow in March and increase the cash weighting in the fund.
We’ve been reducing:
We’ve added to:
As an example:
Mark Niznik and William Tamworth, Artemis UK Smaller Companies
To find out more about the Artemis UK Smaller Companies Fund and their positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
FOR INVESTMENT PROFESSIONALS ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The fund is a sub-fund of Artemis Investment Funds ICVC. For further information, visit www.artemisfunds.com/oeic. 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.
The economic implications of this pandemic are just beginning to be understood. In the UK we have seen one million people applying for Universal Credit in the last month; or in the US, over six million extra people claiming unemployment in one week (nine and half million in two weeks). The world is trying to put their economies on hold, but we don’t know how long that will last. If it proved to be just a few weeks, then we could probably anticipate a V- shaped recovery. However, for now, death rates keep on climbing and until that stabilises and starts to fall then confidence will remain at a low ebb.
The life support to the economy is starting to filter through to further state intervention. The train companies have all been nationalised, as nobody is travelling on them at the moment. The airlines are seeking a bailout. The banks have been barred from paying dividends. At the moment, they are continuing to pay coupons on their junior (Additional Tier 1) bonds, but it’s not a giant leap to stop those too. If I was a shareholder I would be demanding just that. Bonuses are being stopped or capped by the State and credit is being controlled too. Effectively we have nationalised banks without any shareholder compensation.
State intervention in the markets has been enormous, as discussed previously. This is supporting markets. The investment grade bond market is supported by quantitative easing. As a result, the new issue market has been extremely busy, as companies take advantage of this funding source to issue bonds. We have been buying extensively, new issue premiums have been generous and the spreads are considerably wider than a month ago.
As highlighted in previous notes, before the crisis, we had about 43% in government bonds (predominantly US Treasuries). We’ve sold some of these to invest in investment grade bonds. We’re down to 36% and intend to keep on investing, especially in new issues. This week we have bought a range of names including Experian (consumer credit rating), Airbus (aeroplanes) and Iberdrola (Spanish utility) as well as adding to our senior bank bonds such as Danske bank and Intesa as the stopped dividends make the bonds more secure. As an aside, we don’t lose any sleep about liquidity with that US Treasury position.
The high yield market remains in the eye of the storm as there is less intervention, though in the US the authorities are buying high yield exchange traded funds (ETFs). That is working to stabilise a market which was in freefall, as the crisis developed. Moreover, the more defensive names such as bonds issue by telecom companies are in great demand and have performed well. We are not increasing this asset class yet, though it remains at 27% of our total exposure, but we’re not ruling out any good opportunities when they emerge.
Lastly, a brief word on government bonds. As highlighted, whilst confidence is low, then yields will stay subdued too. Our duration is 4.9 years. The danger is that when confidence does start to improve, then markets will focus on the scale of government bond issuance to finance the state support. Yields could then rise quite sharply. There will be a time to shift the duration shorter. However, for now, whilst the UK and the US is in the midst of the most awful increase in death rates, naturally confidence is going to be staying very low.
James Foster and Alex Ralph, Artemis Strategic Bond
To find out more about the Artemis Strategic Bond Fund and its positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The fund is 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.
We have seen the first data releases showing the true scale of economic shutdown. Manufacturing ISM data has fallen sharply in the US and Europe, with services data faring significantly worse. As the service sector has taken such a significant hit, it’s unsurprising that job lay-offs have sky-rocketed. But the 3.25 million new jobless claimants registered last week in the US economy is still eye-watering.
The answer to this has been for central banks to ease and government to unveil huge spending programs. The ECB’s 750 billion euro QE package and the Fed’s unlimited QE, which now finally includes corporate bonds, will help the functioning of markets and lending. An important factor will be how SMEs access the help on offer to prevent wide scale bankruptcies. Government fiscal spending, generally coming in at around 10% of GDP, will also help soften the blow – especially on those most affected by job insecurity – but the true extent of GDP retraction is difficult to quantity due to the length of shutdowns. However an annual GDP hit of 10% for the year – as many forecasters are predicting – would be an outcome politicians would currently take. The short-run effect of this will be demand shock deflation and a surge in defaults. Longer term impacts of on-shoring and large fiscal deficits, together with a change in the public perception of government intervention – accelerating underlying pressures that were already building - will be inflationary. But that is for another day.
So what are markets currently pricing in? The only way to look at it from a credit investor’s point of view is to go through default rate risk and current spreads. With statewide intervention, default rates will be prevented from reaching worst case scenarios. There will be industries, such as energy and retail, where outsized defaults weigh heavily so we are expecting a default rate of around 10%. Most bankruptcies will be concentrated in SMEs which don’t have publicly traded debt. The market is pricing in default rates worse than the great depression of the 1920s – indeed the worst default rates in history. Just last week, the European HY cumulative five-year default rate was priced at around 35%, whilst the US high yield default rate is implied to be around 40%. This is assuming no recovery value. The worst five- year cumulative default rate in history is 32%. The market did have a strong rally in the last few days, but spreads in the US high yield index are still near 1000bps. Whilst economies have collapsed around the world, central bank action along with government support should result in quite a sharp rebound in the second half of the year, preventing default rates from reaching that historically high number.
So while we believe there will be further volatility in the weeks ahead, especially now the shock and awe of central bank and government action has been announced and the markets can now only focus on the raw economic data and unabated earnings downgrades, there are some positive signs. ‘Peak panic’ appears to have ceased. The central bank programs allowed corporate bond buying, enabling greater price discovery in a market that had well and truly frozen. The Fed also announced ETF purchases. This was key as Exchange Traded Funds had collapsed and were trading at huge discounts, becoming forced sellers. With the Fed stepping in, this quickly reversed and they began trading – once more – at a premium, taking out a big forced seller from the market. In fact we’ve had our first HY issue this week (Yum brands in the US), not something we could have envisaged even last week. There are also certain scenarios where risk – particularly cyclical risk – rallies strongly. Antibody tests and covid tracking may allow economies to open up by summer. Indeed whilst some sectors may take a while to recover from this slump – leisure and tourism – we believe others, such as some industrials, will experience a V shaped recovery. Historically, on a 12-month view, spreads have rebounded strongly from these levels.
So what does all this mean for the high income portfolio? As the crises developed, we sold some of our cyclical exposure early on. One of the first names to go was Jaguar due to its exposure to Chinese demand and production. The bonds have since dropped 30%. We also sold our position in telepizza, Oriflame, and cut the majority of E-dreams, AMC cinema chain and Lowen Play. Oil, which was 5% of the portfolio, was our Achilles heel; we had not envisaged the double whammy of the coronavirus with the breakdown of Opec. The bonds have fallen to such an extent that it is now not worth selling. We have prioritised liquidity as the markets deteriorated. We have just over 10% in Treasuries, 11% in liquid equities and 3.5% in cash, with a balanced credit portfolio ensuring liquidity in the portfolio is solid. As markets fell we resisted selling high yield further as, over a 12-month view, we believe that would be the wrong decision. Indeed our last sale was a 1% cut in government bonds. Our last purchase was Virgin Media, a company which will be resilient against the current economic backdrop.
We have the benefit of having managed money throughout the GFC and that experience is valuable. Back then the short-term hit to performance was material, but our willingness to look through the short-term meant that the recovery was similarly sharp. This is worth remembering during a tricky period for everyone. As a sign of how tough it can be to time the HY market we are already finding it difficult to pick up bonds at distressed prices. Hence if we had sold we would be in the unenviable position of not being able to capitalise on the recovery. As mentioned above, the central banks are now buying credit and the support mechanism will be felt widely across the asset class.
Before I turn to the equity component of the fund, it is perhaps helpful to have a brief recap of the role it plays. There are many strong companies out there with attractive dividend yields which compare well to fixed income. They also have a potential for capital growth to an extent which fixed income does not. So over time they will add to total fund returns. In 2019 this number was more than 17%, well worth having. Of course they do also add some volatility, but these short term impacts have always reversed in the past and we would expect them to do so again.
Equities also add an important liquidity component to the fund. Since mid-February we have been selling down our holdings, some at better prices than others. Our exposure currently stands at just under 10% of the fund compared to what we would see as a more ‘normal’ weighting of around 16%. So we have used the flexibility in asset allocation to make sales and generate a partial offset to the inherent equity volatility when measured by the impact on the fund. This also leaves us with flexibility to add to the equity portion again when the time is right: not just yet, but in the coming weeks we expect to see more opportunities.
Achieving a balance of holdings within equities is something we strive for by design. Currently over half of the equity weighting is in what we regard as more defensive sectors, as measured by the robustness of their cashflows; Healthcare, Utilities, Telecoms and Consumer Staples feature prominently via holdings such as Sanofi, DT, Snam, BATS and Rio Tinto. You may be surprised by the inclusion of the latter name, but they have already carried out a streamlining of their business and a balance sheet reset during the last downturn. So we are paying attention to what is in the tin, not just what is says on the tin. The remaining exposure is in more cyclical or semi cyclical names. These will provide the capital upside during a market bounce but in the meantime they all have a healthy level of dividend that we can capture. Overall the equity part of the fund is adding just under 50bps to total fund income, even at our lower level of equity allocation.
Speaking of capturing dividends, this is becoming harder than it used to be. The most obvious example is the ECB’s ‘advice’ to banks not to pay dividends until the situation is reviewed in October. Banks are generally well capitalised unlike during the GFC and the ECB wants it to stay that way. In other sectors companies have either chosen to defer or cancel dividends to conserve cash. Yet more have realised or been explicitly told that if their company is taking government assistance during the crisis the dividend has to go. Dividends have now become a political and in some senses a moral issue.
Our remit is to provide income from the equities and so we have to be robust in changing our holdings if dividends are passed over. A deferral looks exactly the same as a cut to fund cashflows so we have no desire to carry non-income passengers in the boat. Just this week we sold ING and replaced it with KPN for exactly that reason. We have been carefully considering the nature of our holdings and their likely exposure to dividend cuts and will be sure to take similar action again if required.
So overall we are adapting fast to this rapid-fire crisis. We have always maintained a strong liquidity profile and this allows us to trade what we want when we want in our equities but also manage our high yield credit exposure. Our mode at present is defence, but we must always remember that every crisis provides opportunities. Just a few months ago we could lament the paltry yield on offer from high quality stocks and bonds. Many of these have become cheaper and, particularly in equities, are likely get cheaper again as the crisis rolls on. Once we can see an end to further incremental bad news we should be able to pick up yield bargains within equities and high yield bonds that serve us well for a long time to come. In the meantime, we are able to pick up defensive quality bonds at very attractive yields.
Alex Ralph, Artemis High Income
To find out more about the Artemis High Income Fund and its positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The fund is 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.