Artemis UK Smaller Companies Fund
Q1 2025 update

Review of the quarter to 31 March 2025.

Artemis UK Smaller Companies fell 4.9% in the first quarter of 2025, compared with losses of 6.3% from its Deutsche Numis UK Smaller Companies (-InvTrust) benchmark and 7.4% from its IA UK Smaller Companies sector average.

The January-to-March reporting season is an important one, as a large proportion of companies have a December year-end. Results on the whole were:

• Generally resilient…
  Most results were ‘in line’ (43%) or ‘broadly in line’ (31%). This is in keeping with our view that trading is generally resilient and, whilst not ‘strong’, is certainly less bad than the prevailing narrative surrounding the UK.

• …albeit with more downgrades than upgrades…
  It is typical for downgrades to exceed upgrades, as analysts tend to be overly optimistic. For 7% of the fund, earnings expectations were cut by more than 10%, compared with 5% that saw earnings expectations increase by more than 10%.

• …but our fund had fewer warnings than the benchmark
  Just 7% of holdings in the fund saw downgrades of more than 10%, compared with 18% for the wider benchmark.

There were no major surprises in the UK Spring Statement. The ‘fiscal headroom’ was restored through a series of spending cuts, including to welfare (£3.4bn), real departmental spending growth (from 1.3% down to 1.2%) and overseas aid.

Artemis UK Future Leaders PLC

We were delighted to take on the investment management responsibilities for the Artemis UK Future Leaders PLC (previously Invesco Perpetual UK Smaller Companies IT PLC) on 10 March. Artemis UK Smaller Companies and Artemis UK Future Leaders will be run with the same aims: capturing the small-cap premium, adding value through stock selection and reducing risk. We will also use the same investment approach which will continue to emphasise valuation discipline, cashflows and a long-term investment horizon. The closed-ended nature of the investment trust will enable us to hold more micro caps, add modest gearing and run a slightly more concentrated portfolio. Artemis UK Future Leaders currently pays a 4% dividend.

Positives

The continued rehabilitation of defence was one of the biggest positive contributors to performance over the quarter. The fund has 7% in this sector (compared with just 1% from the benchmark) with significant holdings in Babcock, QinetiQ and Chemring. Including Serco, which generates about 40% of its revenues from defence, this rises to about 10% of the fund. These holdings have market-leading positions in specific niches and we were able to acquire them at attractive valuations when they were out of favour. Babcock was the single biggest contributor to performance during the period, after upgrading its profits due to strong growth in its nuclear and marine businesses.

M&A activity continues to act as a tailwind for the fund, with Alliance Pharma receiving a recommended offer from DBAY and caterer Bakkavor’s shares rising after a takeover approach from Greencore.

Elsewhere, Secure Trust Bank also made a strong contribution and we are confident that the vehicle finance impairments of 2024 will not be repeated.

Negatives

Construction company Severfield was the biggest detractor from performance after it suffered from tighter pricing as well as delays and cancellations to existing contracts.

After a strong positive reaction to results released in December, RWS fell significantly, despite little news flow. It may have been affected by growing concerns about the impact of AI, but this could be an opportunity for the company as well as a threat. In addition, new chief executive Benjamin Faes has yet to set out his stall. We topped up our position.

Beeks Financial Cloud, a significant contributor to performance in recent quarters, fell on the loss of one contract and caution around the speed at which new exchange cloud contracts will contribute to revenue.

From a relative point of view, we suffered from not holding Ithaca Energy, TBC Bank, REIT (real estate investment trust) Assura and Hochschild Mining.

Past performance is not a guide to the future. Source: Lipper Limited to 31 March 2025 for class I Acc 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. This class may have charges or a hedging approach different from those in the IA sector benchmark. 

Purchases

Using cash recycled from recent takeovers, we (re)started a holding in 4imprint, having previously sold out at the start of 2020. 4imprint is the leader in the fragmented US promotional products market. It has an excellent long-term record of taking market share in a growing (albeit cyclical) market. There is substantial scope for further expansion and, as the business grows, it can continue to increase its marketing spend which is already higher than that of its competitors.

We also started a holding in Netcall, which provides digitalisation software to help businesses and governments reduce costs. Its key competitive advantage is its easy-to-use software, as you do not have to be a coder to use it. There are also network benefits: for example, if one local authority customer creates an app, it can be used by the other local authority customers on the platform. It has attractive traits that are rare in the UK small-cap market, such as fast-growing recurring earnings with a high retention rate at a high gross margin, which should drive strong operating leverage.

Another new position, Energean, benefits from long-term gas contracts and a free cashflow yield of more than 20%. Its directors recently purchased a significant number of shares, which we regard as another positive indicator.

We added to existing holdings in Hollywood Bowl, Gamma Communications and Victoria Plumbing.

Sales

Takeovers were responsible for some of our most significant sales over the quarter (Alliance Pharma, Britvic and payment provider Eckoh).

We took profits from SigmaRoc due to strong recent performance and some concerns about the company’s acquisitive model.

Outlook

UK small and mid caps are seven years into a secular bear market (defined as an extended period in which stock price returns are significantly below the long-term average). Historically, buying after periods of weak returns has resulted in strong future returns.

When it comes to tariffs, it is hard to add much to the debate. We would simply point out the fund derives 62% of revenues from the UK and only 15% from the US. The UK economy is not heavily dependent on exports of goods. But even if it is relatively well positioned, uncertainty is bad for confidence on an absolute basis and likely to supress economic activity.

Since Brexit, UK investors have become all too familiar with the concept of a 'political risk premium'. In contrast, the US has been blessed by a narrative of 'US exceptionalism'. The recent BofA Global Fund Manager Survey provided an early indication that investors are starting to reappraise this received wisdom with a shift out of the US and into the UK. Given the dominance of the US in global equity weightings, it would only take a small realignment to have a meaningful impact on UK equity valuations.

We will soon have a clearer indication of the impact of the increase in national insurance contributions, which come into effect from April. Our expectation is this will be inflationary, but less detrimental to employment than feared. But as we have been saying for some time, ‘less bad’ could be all it takes for a recovery in consumer, business and investor confidence.