Artemis Funds (Lux) — US Smaller Companies
Q3 2024 update

Artemis Funds (Lux) - US Smaller Companies is an actively managed fund. The fund's objective is to increase the value of shareholders’ investments primarily through capital growth. The fund invests principally in equities of smaller companies that are listed on a recognised stock exchange in the USA. Typically, these are companies with a market capitalisation of less than $10bn at the time of purchase. 

The quarter began with softer inflation data and the Federal Reserve expressing confidence that it would continue to fall towards their target of 2%, leading markets to interpret this as a clear sign of potential 'dovish' cuts in September. This caused a violent rotation in markets as investors reduced their negative bets on smaller companies. In the second week in July, the Russell 2000 index rose strongly.  

However, by mid-July, signs of stress around the health of the US economy started to filter through to equity markets. These tensions were exacerbated at the start of August by a weaker-than-expected jobs report and a rise in the unemployment rate, triggering the Sahm Rule¹, a key indicator of a recession. On top of these domestic concerns, the Bank of Japan’s decision to raise interest rates put pressure on global financial markets, particularly on the Yen carry trade—a strategy in which investors borrow in low-yielding currencies like the yen to invest in higher-yielding currencies. These events led to a complete reversal of the gains the index had experienced in the first half of July.

Despite these initial headwinds, by late August, more supportive economic data began to emerge, including stronger retail sales and better-than-expected weekly jobless claims in the US. These reports alleviated some of the immediate fears of an imminent recession, allowing the Federal Reserve to proceed with its first rate cut.

The Russell 2000 finished the period up 9.2%, (in US dollar terms) and more interestingly ahead of the S&P 500, an unusual occurrence in a time when the largest companies have been driving returns in the US. 

Performance

Past performance is not a guide to the future. Source: Lipper Limited/Artemis to 30 September for class I accumulation USD. All figures show total returns with dividends and/or income reinvested, net of all charges. Performance does not take account of any costs incurred when investors buy or sell the fund. Returns may vary as a result of currency fluctuations if the investor's currency is different to that of the class. 

During this period, the fund underperformed the index returning 6.4% vs. the Russell 2000 index's 9.2%. Year to date the fund remains comfortably ahead returning 16.8% vs. 11.1%. Main detractors over the three months from a sector perspective were our holdings within technology and consumer discretionary. Partially offsetting weakness was our utility and energy exposure. Our holdings within these sectors have benefited from the broader pick-up in demand for clean energy, a theme we continue to be well-positioned in.

On the negative side, Elf Beauty suffered with the business revealing that sales trends fell short of the market's forecasts, causing it to revise down estimates over the quarter. Within our technology exposure, Western Digital underperformed as it is closely tied to concerns around AI-related capital expenditure. Despite near-term headwinds, we maintain our long-term positive outlook on the company, as its memory chips will be critical to AI infrastructure. Weatherford International, an oil services company that assists in drilling and maintaining oil and gas wells, was impacted by weaker oil prices and challenges within the energy services sector. We decided to sell the position and reallocate to opportunities with a more attractive risk reward. Finally, within our financials exposure, LPL Financial struggled with declining net interest margins. Clients moved cash from low-yielding accounts into higher-yielding alternatives, which negatively impacted profitability.

On the positive side, Vistra was the largest contributor to performance. The independent power producer benefits from its exposure to both gas and nuclear energy, which are increasingly in demand, especially from data centres seeking cleaner energy solutions. The decline in interest rates also provided a further boost to this capital-intensive industry.

Within our financials exposure Jones Lang LaSalle and Jefferies contributed. Both businesses stand to benefit from a pick-up in deal activity within property and capital markets respectively. Both have attractive idiosyncratic characteristics that make them more interesting opportunities than the more traditional financials within the US small and mid-cap universe which tend to lose out to their larger peers.

Within our industrials exposure, Axon Enterprise continued to benefit from strong demand for its body cameras and the new AI-driven report writing tool, which helps streamline law enforcement operations. Axon’s consistent revenue growth remains a key driver of its performance.

Activity

We made a number of changes over the period. We bought positions in companies set to benefit from tight supply-demand dynamics and long-term growth trends. For example, Kirby, a domestic barge operator, was added to the portfolio due to high utilisation rates and positive pricing. The fund also increased its exposure to Affirm Holdings, a leading "buy now, pay later" company, which is expected to grow alongside the expanding e-commerce sector. Additionally, we initiated a position in HudBay Minerals, a copper mining company well-placed to capitalise on the global energy transition towards renewables.

We sold the fund's positions in Weatherford International and Ralph Lauren. The decision to sell Weatherford was driven by persistent weakness in the oil services sector. In the case of Ralph Lauren, we concluded that the investment thesis had played out, and better opportunities were available elsewhere. The fund also reduced its holdings in Core & Main and Elf Beauty due to weaker-than-expected guidance and slower sales trends, respectively.

Outlook

As we emerge from the summer months that have been characterised by volatility both in markets and in estimations of the health of the US economy, we don’t feel that we are entering a period of calm in markets. Our process of identifying businesses with attractive risk-reward profiles has proved essential in guiding the fund through this volatile period. We have a clear framework around modelling the downside scenario in addition to modelling the upside. In times of volatility this is extremely helpful as you can immediately understand if there is overoptimism or undue pessimism.

We are acutely aware of the upcoming election, with each party representing quite different policy objectives. As we approach the date, we expect to be spending a significant amount of time modelling the different outcomes on a stock-by-stock basis to understand the implications.

To reiterate the case for US smaller companies…

• Their valuations relative to large caps are still at multi-decade lows.
• They are more domestically wired allowing us to capture the intricacies of American economy more directly.
• The breadth and depth of the market means that we can target specific themes such as housing shortage, AI investment, fiscal expenditure or onshoring more effectively.

Discrete performance, 12 months to 30 September (%)

Past performance is not a guide to the future. Source: Lipper Limited/Artemis to 30 June 2024 for class I Acc USD. All figures show total returns with dividends and/or income reinvested, net of all charges. Performance does not take account of any costs incurred when investors buy or sell the fund. Returns may vary as a result of currency fluctuations if the investor's currency is different to that of the class.