Artemis UK Special Situations Fund
Q3 2024 update

As economic growth began to slow during the quarter, stimulus was front and centre of the policy agenda. The Federal Reserve cut interest rates by 50bps while the Chinese government announced both monetary and fiscal stimulus, prompting a sharp rally in direct Chinese equities. UK-listed companies with high exposure to the Chinese economy also benefited. The immediate economic outlook did however lead to defensive stocks outperforming in the quarter, representing something of a headwind to the fund’s relative performance.

Against this backdrop, the fund rose 1.7% in the three months to the end of September, with the FTSE All-Share rising by 2.3%.

Past performance is not a guide to the future. Source: Lipper Limited/Artemis as at 30 September 2024 for class I accumulation GBP. 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. Classes may have charges or a hedging approach different from those in the IA sector benchmark.

Stock positives

Banks continued to deliver strong performance in the period as interim results provided more evidence that returns are improving in line with management teams' targets. Buybacks are continuing at pace.

Entain bucked its recent run of poor results and increased profit guidance after a strong second quarter. The Euro 2024 football tournament this summer certainly helped, but product improvements were of more significance to us and an increased marketing budget should further strengthen growth in the second half. Gavin Isaacs has now joined as chief executive, bringing with him a strong track record in the industry. We were impressed upon meeting him.

IG Group has also appointed a new chief executive, Breon Corcoran, who sees potential for the business to build revenues by speeding up decision making and increasing marketing and acquisitions. In general, the tone is one of a cultural reset to improve accountability. The shares rallied from their low valuation on this renewed confidence in the company’s ability to deliver growth.

Stock negatives

Babcock reported good results, with revenue growth, margins and cashflow all ahead of expectations. This was offset by news earlier in the quarter that management took an additional £90m provision against the Type 31 frigate contract. This is the remaining fixed-price ‘problem’ contract that the new management team inherited. The shares gave back some of their year-to-date gains, but on balance we believe the positives outweigh the negatives.

Many industrial companies such as TT Electronics and Essentra (neither of which we hold) have warned of tough trading, with anticipated second-half recoveries failing to appear. A China resurgence remains elusive, the EU is slowly exiting an industrial recession and US end-markets have softened a touch. Against this backdrop, our holdings in Oxford Instruments, Morgan Advanced Materials and Bodycote underperformed.

Activity

New idea generation remains strong and we introduced four new holdings to the portfolio in the quarter.

Rosebank Industries is the new venture launched by Melrose’s previous management team, which aims to acquire underperforming industrial assets and implement its 'buy, improve, sell' strategy. The position is currently modest but will increase as we intend to support the acquisition-related fundraise when the team finds its first target company.

Having met specialty insurer Beazley in March we were impressed with the track record of growth and its approach to underwriting; particularly in cyber insurance where it has a 10% market share. The CrowdStrike outage in July affected an estimated 8.5 million Windows devices worldwide and, as such, offered us an opportunity to assess Beazley’s ability to manage cyber risk in a real-life scenario. Profit guidance was unchanged. We feel the 20% annual returns that the company can deliver are not adequately captured in the valuation.

Domino's Pizza, a past darling of the UK mid-cap market, has underperformed in recent years. Entry into non-UK markets, friction between the PLC and the franchisees and fragmentation in the delivery market have all weighed on returns. However, Domino's remains the market leader in UK pizza delivery and has now partnered with both Uber Eats and Just Eat. It has also resolved the impasse between the franchisees and the PLC. The new chief executive, Andrew Rennie, is a veteran of the industry and a previous Domino's franchise operator. He expects an acceleration in store growth and improved order frequency via the introduction of loyalty programmes, new menu options and a refreshed national advertising campaign.

Hunting serves the energy, aerospace and general industrial market with precision tooled products. Serving disparate markets has been a challenge for a business that lost focus on margins and cashflow generation. However, after coming through a period of restructuring and portfolio realignment, the company has just introduced an ambitious strategic plan.

We sold our holding in Ryanair after a change in our view on its future earnings power, related to concerns that price increases pushed through since 2019 could lead to demand destruction. The sharp reduction in airfares over the summer suggests that supply is now outstripping demand at these higher ticket prices. With future supply growth underpinned by industry aircraft orders, we believe that the weaker pricing environment may last longer.

We also sold our longstanding holding in Pearson after a valuation re-rating. A new chief executive aims to improve revenue and margin growth, but we are of the view that much of the upside is now in the price. We see greater upside elsewhere.

Engagement

We met Jay Dossetter, Entain’s head of sustainability, to discuss the firm’s recently published ESG report. The meeting focused on the company’s goal of a being a leader in player protection.

We also met IG Group’s chairman Mike McTighe to discuss the organisation’s reaction to its new chief executive. McTighe was positive on early impressions while acknowledging that wider cultural change and greater accountability will take time.

Outlook

The new UK government's desire to clean the slate and apportion blame to the prior regime has led to some depressing headlines on tax increases and spending austerity. Animal spirits are being kept in check. By emphasising an uncertain outlook, we can understand why someone might delay that new sofa until next year, stick with the same car or downgrade the holiday budget. While consumer sentiment has improved from its lows, the UK savings ratio now sits above 10%, even though Covid savings remain intact. Timing is uncertain, but the setup for a consumer recovery remains attractive. Our portfolio reflects that confidence.