Artemis Strategic Bond Fund

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1 Artemis Strategic Bond Fund Manager s Short Report Investment objective and policy The fund seeks to achieve a combination of income and capital growth by investing predominantly in fixed income markets. The fund aims to achieve its objective by investment predominantly in fixed income markets but may selectively invest in other markets. Equal emphasis is given to the security of capital and income although from time to time one may take prominence over the other in accordance with the strategy being pursued. The fund may also invest in other transferable securities, units of collective investment schemes, money market instruments, warrants, cash and near cash, derivatives and forward transactions and other investments to the extent that each is permitted by the regulations. Risk and reward profile Typically lower rewards Lower risk Typically higher rewards Higher risk This indicator is based on historical data and may not be a reliable indication of the future risk profile of the fund. The risk category shown is not guaranteed and may change over time. A risk indicator of 1 does not mean that the investment is risk free. The indicator is not a measure of the possibility of losing your investment. The risk indicator for the fund is as above because: The price of units, and the income from them, can fall and rise because of stock market and currency movements. Stock market prices, currencies and interest rates can move irrationally and can be affected unpredictably by diverse factors, including political and economic events. A portion of the fund s assets may be invested in a currency other than the fund s accounting currency (sterling). The value of these assets, and the income from them, may decrease if the currency falls in relation to sterling, in which the fund is valued and priced. Investments in fixed interest securities are subject to market and credit risk and will be impacted by movements in interest rates. Interest rate movements are determined by a number of economic factors, in particular market expectations of future inflation. The fund can invest in higheryielding bonds, which may increase the risk to your capital due to a higher likelihood of the company issuing the bonds failing to pay returns on investments. Changes to market conditions and interest rates can have a larger effect on the values of higheryielding bonds than other bonds. The fund may hold derivatives with the aim of profiting from falling prices. For the year ended 31 March 2015 If the related assets rise in value the fund will lose money. Whilst investing in the units that pay or reinvest income each month (class M units) will produce a regular income, it may restrict the potential for your units to increase in value in comparison to the units that pay or reinvest income every 3 months (class Q units). Fund information Launch date 1 June 2005 Unit types MR MR MI MI QR QR QI QI IMA sector Strategic Bond Distribution yield * MR 4.1% MR 4.1% MI 4.6% MI 4.6% QR 4.1% QR 4.1% QI 4.6% QI 4.6% Accounting dates 30 September & 31 March Distribution dates MR & MI classes Distribute on a monthly basis QR & QI classes Distribute on 30 April, 31 July, 31 October & 31 January Launched on 1 April * The yield reflects the amounts that may be expected to be distributed over the next 12 months as a percentage of the mid-market unit price of the fund as at the date of this report. It is based on a snapshot of the portfolio on that day. It does not include any preliminary charge and investors may be subject to tax on s. 1

2 Artemis Strategic Bond Fund Manager s Short Report Investment review Fund returns 4.8%* versus 6.6%* for the sector average. Our caution regarding long bonds held back short-term returns. We expect healthy returns to continue. Performance Caution costly in the short-term, but the long-term is good The fund returned 4.8%* for the year. Our peer group averaged 6.6%* and the Markit iboxx Sterling non-gilts Index returned 13.1%*. Long bonds did well in the year under review. Our more cautious strategy of avoiding this area did not pay off this year - though it did last year. Even so, owning longdated government bonds is risky, in our view; and we see no reason to change our stance as we explain below. Meanwhile, and as we approach the 10th anniversary of the fund in June, it is pleasing to see that the sector average return was 47.9%* and that we have generated 69.5%* for our unitholders over this decade. Review In interesting times Our job is constantly fascinating and the last 12 months have not disappointed. This time last year we were commenting that interest rates looked likely to increase after a long decline. Yields on government bonds were moving to reflect this. And we felt we had negotiated our way through the tricky bond markets running up a down escalator, in effect. Then the escalator stopped. Since the beginning of 2015, interest rates have fallen in more than 40 countries. Low inflation seems to be becoming entrenched. The central banks are worrying that deflation may take hold. This would be a very real threat to the economy because it would discourage consumers from spending. This is what has happened in Japan: deflation has taken hold over the last decade and is proving difficult to overcome. In Europe, stubbornly low demand has led to bold action at last. After many years of scoffing at others for printing money, the European Central Bank (ECB) has adopted the same policy. Germany struggles with the concept: the hyper-inflation of the 1920s, and the damage caused to its economy, is written into the country s textbooks. So it took a long time to persuade it (and others). But this spring, Mario Draghi, the ECB president, launched a programme of quantitative easing (QE) that dwarfed expectations. It was as big as anything seen in the UK and the US. Only time will tell if this policy actually works. It is due to continue at least until next year s annual report on this fund, so we will comment then. Inflation, however, has been low for a number of reasons. Not only has demand been low, but oil prices have plummeted in the last six months. This takes a long time to work its way through the system. So lower oil prices will continue to benefit consumers for the rest of this year, at least. This should help growth and has reduced inflationary expectations. Indeed, inflation has fallen to zero in the UK and the US, and is negative in Europe. How much of this is due to oil is difficult to fathom, but the central banks are not going to raise rates with inflation this low. Bond yields are moving to reflect this. They are negative in many European economies as they are now for bunds up to seven years in maturity. The German government is being paid to borrow money; investors are guaranteed to lose money. This is hard to understand. But it reflects an extreme wariness of risk. Or, looked at differently, investors anticipate deflation in the future. It is a consequence of the QE programme. All in all, we are living in extraordinary times. European bond yields have never been this low before, with history going back to the 17th century for some countries. Admittedly, US yields have been lower, but they fell sharply throughout the year as lower oil prices delayed a rise in interest rates. Increases have also been deferred in the UK, despite heavy hints from the Bank of England. More than a year ago, governor Mark Carney extolled the virtues of forward guidance. He also suggested unemployment below 7% might be a signal to raise rates predicting it could take three years to achieve. How wrong he was: it took six months. Unemployment is now well below 6% and rates still haven t been raised. The reason? Wage inflation is very low. This is also true in the US. Low unemployment is not feeding through to higher pay which would lead to general inflation. The effect is spilling over into investment-grade and high-yield bond markets. Investors need a yield. Historically government bonds have provided that. Without taking the risk of Greek or Ukrainian bonds, investors are looking at the alternatives. Corporate bonds have performed extremely well, with yields falling. Moreover, companies have been issuing bonds at coupons lower than their dividend yield to buy back shares. Some Nestle bonds even have a negative yield. Making sense of this is not easy. High-yield bonds have benefitted from the environment of lower yields, though it has been a bit of a rollercoaster. Mid-year, Janet Yellen of the Federal Reserve made some cautious comments about the high-yield bond market. Combined with poor headlines about defaults from oil stocks, the US market, in particular, struggled. The European market has fewer oil-related stocks and outperformed, which helped our performance. We increased our weighting in high yield bonds by more than 5% after Christmas when sentiment was poor. This has been beneficial for the fund. We have also benefitted from healthy * Source: Lipper Limited, QR, bid to bid basis in sterling with net income reinvested to 31 March Benchmark is the Markit iboxx Sterling non-gilts Index. 2

3 positions in financial and hybrid bonds. Both performed exceptionally well, despite weak oil prices undermining some of the utilities. We feel that this trend is set to continue, especially among the banks. Here dividends are rare and regulators remain determined to set higher capital requirements. This makes your bonds safer. Outlook Looking at liquidity There have been many reports about poor liquidity and this could become a problem. The bond markets have developed into a shadow banking system, which increases the risk to all. We believe that there are two main factors behind this. Firstly, traders at banks are no longer paid by results: they are salaried staff, with bonus caps and claw-backs. So they have little incentive to take positions. If they get it wrong, they lose their job and potentially previous bonuses. Get it right and their rewards are limited. Secondly, banks no longer run big trading books. Their cost of trading has been deliberately increased by the regulators so banks are avoiding taking the risk. The aim may have been worthy; banks clearly don t know how to behave, as demonstrated by the financial crisis. But the consequences for the bond markets have been a marked reduction in liquidity. We will just have to get used to it. Meanwhile, to protect our investors, we are holding a greater proportion of shorter dated securities. These would be less affected by a general sell-off in the market and provide us with a steady stream of cash to invest back into weaker markets or to meet redemptions, if required. Another big concern for investors is the great rotation back into equities. This could create a sharp drop in prices. But it is only likely, we feel, if a bout of inflation necessitates a sharp rise in interest rates. With inflation currently zero, this doesn t feel like an imminent threat. So, although liquidity is poor, we don t believe it will cause dysfunctional markets in the short term. Longer term, it may be inevitable. But given the significance of the bond markets as a shadow banking system, the central banks would quickly feel compelled to intervene. We often hear comments about bonds having had such a good run arguably for 30 years that surely it must end soon. Then every year they beat expectations. Of course there are risks. At the time of writing we are in the middle of an election campaign. But, despite their differences, the priority of the main parties is to reduce the deficit, rather than increase it. That is positive for bondholders and will tend to keep interest rates lower for longer. Clearly inflation could take off. We feel that that would need a collapse in sterling and an increase in wage inflation. Recently sterling has been strong and wage inflation has been remarkably low. Looking overseas (where inflation is often created), deflation seems to be more of a risk at the moment. Perhaps the biggest danger is the excess debt in the system. Since 2007, global corporate debt has increased from $38 trillion to $56 trillion and there is no sign of that appetite reducing. Our feeling is that demand is still very strong, because interest rates are low and because of regulation. Given that governments still want cheap finance themselves, those regulations are unlikely to be relaxed significantly. So while cautious, we feel the outlook is optimistic. We have all the tools available to us to protect the portfolio when the interest rate cycle turns. (In practice, we are now seeing some countries introducing negative interest rates). Our enthusiasm for the asset class remains and we believe healthy returns can still be generated. James Foster and Alex Ralph Fund managers 3

4 Artemis Strategic Bond Fund Manager s Short Report Investment information Portfolio split Ten largest investments 31 March 2015 % of net assets 31 March 2014 % of net assets Investment 31 March 2015 % of net assets Bonds Federal Republic of Germany 1% AAA rated AA rated A rated BBB rated BB rated B rated CCC rated C rated Equities Forward foreign exchange contracts (0.24) 0.24 Futures - - Net other assets Net assets Source for bond ratings Artemis Investment Management LLP. US Treasury 0.25% RSA Insurance Group 5.125% Volkswagen International Finance 4.625% Perpetual 1.46 PGH Capital 5.75% RWE AG 7% Perpetual 1.33 Orange 5.875% Perpetual 1.31 SSE FRN Perpetual 1.30 GE Capital Trust V 5.5% ING Bank 4.125% Investment 31 March 2014 % of net assets US Treasury 0.25% ABN Amro Bank FRN Perpetual 1.52 BG Energy Capital 6.5% RWE AG 7% Perpetual 1.48 RSA Insurance Group 8.5% Perpetual 1.36 IPIC GMTN 5.875% Aberdeen Asset Management 7% Perpetual 1.29 ENBW 7.375% America Movil 6.375% Boparan Holdings Limited 9.875%

5 Comparative tables Fund sizes & net asset values Date Net asset value of fund ( ) 31 March ,718,449 Net asset value per unit Units in issue MR ,876,388 MR ,928,124 MI ,675,876 QR ,952,323 QR ,399,663 QI ,423, March ,069,869 MR ,586,629 MR ,299,419 MI ,450,025 QR ,167,692 QR ,945,038 QI ,463, March ,856,442 MR ,321,065 MR ,930,549 MI ,166,332 MI ,058,069 QR ,322,650 QR ,616,416 QI ,335,311 QI ,155,676 Net revenue & unit price range Year Net revenue per unit Highest offer price Lowest bid price MR * MR * MI * MI 2014 ** * QR * QR * QI 2014 ** * QI * Net revenue includes all amounts paid and payable in each calendar year. * To 31 March ** From 1 April

6 Artemis Strategic Bond Fund Manager s Short Report Comparative tables (continued) Distribution tables Monthly s for the year ended 31 March 2015 Payment date MR MR MI MI 30 May June July August September October November December January February March April Monthly s for the year ended 31 March 2014 Payment date MR MR MI 31 May June July August September October November December January February March April Quarterly s for the year ended 31 March 2015 Payment date QR QR QI QI 31 July October January April Quarterly s for the year ended 31 March 2014 Payment date QR QR QI 31 July October January April Ongoing charges Class 31 March 2015 MR 1.08% MR 1.08% MI 0.58% MI 0.58% QR 1.08% QR 1.08% QI 0.58% QI 0.58% Ongoing charges shows the annual operating expenses of each unit class as a percentage of the average net assets of that class for the preceding 12 months. Fund performance Artemis Strategic Bond Fund Markit iboxx Sterling non-gilts Index Since launch * 5 years 3 years 1 year 6 months Sector average Position in sector 6/28 24/45 23/54 38/62 30/63 Quartile * Data from 30 June 2005, due to the fixed price period of the fund. Source: Lipper Limited, QR, bid to bid in sterling with net income reinvested to 31 March All performance figures show total return percentage growth. Sector is IMA Strategic Bond. Value of 1,000 invested at launch to 31 March ,000 1,800 1,600 1,400 1,200 1, Artemis Strategic Bond Fund (QR ) Markit iboxx Sterling non-gilts Index Jul 06 Sep 08 Nov 10 Jan 13 Mar 15 6

7 General information Report & accounts This document is the Short Report of the Artemis Strategic Bond Fund for the year ended 31 March The Annual Report and Financial Statements can be obtained from the manager s website artemis.co.uk, by contacting the Client Services team on or by writing to the manager s address below. Manager Artemis Fund Managers Limited * Cassini House 57 St James s Street London SW1A 1LD Dealing information: Unit Trust Department Artemis Fund Managers Limited PO Box 9688 Chelmsford CM99 2AE Telephone: Website: artemis.co.uk Investment adviser Artemis Investment Management LLP * Cassini House 57 St James s Street London SW1A 1LD Trustee National Westminster Bank Plc Trustee & Depositary Services Younger Building 1st Floor, 3 Redheughs Avenue Edinburgh EH12 9RH Registrar International Financial Data Services (UK) Limited * IFDS House St Nicholas Lane Basildon Essex SS15 5FS Auditor Ernst & Young LLP Ten George Street Edinburgh EH2 2DZ. * Authorised and regulated by the Financial Conduct Authority (FCA), 25 The North Colonnade, Canary Wharf, London E14 5HS. Authorised by the Prudential Regulation Authority (PRA), 20 Moorgate, London EC2R 6DA and regulated by the PRA and the FCA. 7

8 Keep up to date with the performance of this and other Artemis funds throughout the year on Artemis website Monthly fund commentaries and factsheets Artemis Filmclub videos by our fund managers Market and fund insights Fund briefings and research articles The Hunters Tails, our weekly market newsletter Daily fund prices Fund literature artemis.co.uk 8