Artemis UK Smaller Companies Fund
Q3 2025 update

Review of the quarter to 30 September 2025

The takeover theme of recent years continued during the third quarter with US-listed corporate payments company Corpay’s agreed cash bid for Alpha Group – the B2B cross border FX solutions provider and our largest holding at the time. Meanwhile, FirstCash’s acquisition of pawnbroker H&T was completed in August and earlier this year, food manufacturer Bakkavor received an offer from its peer Greencore.

Together with the record number of companies buying back their own shares, we see these deals as evidence that corporate management teams see the UK small-cap market as good value.

Our fund has had more than its fair share of bids in recent years – a trend we expect to continue unless valuations increase substantially. Importantly, there is no shortage of opportunities to redeploy the proceeds in other attractively valued companies.

Performance

The fund underperformed during the third quarter, down 2.7% against a flat peer group and a rising market. A general deterioration in sentiment towards UK domestic stocks – where we continue to be overweight – has been unhelpful. Although this has been a drag on recent returns, we believe the commensurately lower valuations of these stocks create an opportunity for the future.

Real household disposable income remains strong but UK consumers are deferring spending, choosing to save instead. Once confidence improves and spending picks up, we believe our holdings have the potential to make substantial returns.

The fund's long-term performance remains robust and it is a top-quartile performer in the IA UK Smaller Companies sector over three, five and 10 years.

Past performance is not a guide to the future. Source: Lipper Limited to 30 September 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.

Negatives

Cosmetics company Warpaint London was the most significant detractor during the quarter, following a downgrade on lower US revenues due to tariffs and because a large Scandinavian customer reduced buying for two months.

AOTI, a leader in wound care technology, warned of weaker than expected growth in US Medicaid and veterans affairs reimbursement, following cost cutting by the Department of Government Efficiency (DOGE).

Accesso Technology Group, which provides virtual queuing technology and ticketing software, issued a profit warning after its largest theme park customer (Six Flags) brought its queuing application back in-house.

Elsewhere, package holidays provider On The Beach cut its profit forecasts due to later customer booking and the closure of its small B2B business.

Positive contributors

Banks were the portfolio’s strongest sector during the quarter and Secure Trust Bank made the largest contribution to performance. It gained 42% in Q3 on the back of positive H1 results and increasing confidence that it will deliver on its near-term return on equity target. Medium term targets are likely to be revised higher later in the year, following the bank’s decision to exit its loss-making motor finance business.

Alpha Group's share price climbed 31% during the quarter, following Corpay’s aforementioned cash bid. At 4250p per share – a 55% premium to the undisturbed price – this feels like a reasonable offer to us. It values Alpha at a price-to-earnings (P/E) ratio of 45x (which does not include interest income) with a free cashflow yield of around 5%.

Next 15 gained 41% during the quarter. Investors could be speculating on the previous announcement of takeover interest in some of the group’s companies.

Potential M&A activity also boosted JTC, the corporate services and fund solutions provider, which gained 54% on the back of two cash takeover approaches from private equity firm Permira (both of which were rejected by JTC’s board).

Purchases

We initiated new positions in Niox, Greggs, Ashtead Technology and Science Group during the review period.

Niox, which we already held in the Artemis Future Leaders plc investment trust, makes the leading device for diagnosing asthma from a patient’s breath. Revenues have been growing by 10% to 15% a year, with 70% gross margins and low capital requirements leading to strong cash generation. About 90% of its earnings are recurring and it has a global market share of 80%. We were encouraged by a strong trading update after its shares fell when a potential cash bid was withdrawn. The valuation looks reasonable on a 6.5% free cashflow yield for next year.

After a 10-year hiatus, we restarted a holding in Greggs. An 8% free cashflow yield is attractive for a company with an excellent long-term record, a strong balance sheet and significant scope to continue rolling out new stores (at high incremental returns) without cannibalising existing sales. The share price has suffered from challenging short-term trading (partly weather related) which we see as an opportunity.

We also opened a modest position in subsea equipment-rental firm Ashtead Technology. The combination of forced sellers (about 20% of its shares were held by AIM funds which had to sell before the company moved to the main market on 6 October) and a modest earnings downgrade had driven the valuation to a P/E of 7x or a double-digit free cashflow yield. While this is a cyclical business, it operates in growth markets and the critical nature of its products (with a disproportionally high cost of failure) means it can sustain high returns.

Science Group has two main divisions: one is a Cambridge consultancy specialising in technical and scientific projects, with a global niche position in robotic surgery and drug delivery; the other sells kit that removes cardon dioxide from submarines and replaces it with breathable air. Around one third of the market cap is forecast to be in net cash next year, giving the company scope to continue accretive bolt-on acquisitions. A P/E of 14x or a 7% free cashflow yield for 2026 feels good value.

We also took part in a placing of new shares in thread manufacturer Coats, which raised money to fund its acquisition of Ortholite. Ortholite makes open-cell foam insoles for trainers, which are breathable and provide cushioning. It already has more than 35% of the global market in open-cell foam insoles (which in turn account for about 25% of the overall insole market) and continues to grow its market share.

Coats' shares have been supressed by concerns regarding US tariffs but trading has remained resilient so far. If it can achieve its medium-term targets of organic growth above 5% at 19 to 21% margins, the 10% free cashflow yield looks very attractive.

We added to several holdings during the quarter on share price weakness, including Gamma Communications, Hilton Food, GB Group and Mears.

Sales

We took profits from Secure Trust Bank following very strong performance and trimmed Serco, Brooks Macdonald and QinetiQ on share price strength. We also trimmed some of our consumer-facing holdings (Dunelm, Wickes and J D Wetherspoon) to enable the purchase of Greggs without materially increasing our exposure to an area where we already have significant exposure. We sold out of Alpha and Bakkavor ahead of the completion of their recommended offers.

Outlook

We are expecting an increase in negative headlines in the run-up to the Autumn Budget on 26 November, which could affect confidence and therefore consumer spending in the short term. But ultimately consumer spending is dictated by economic fundamentals and we believe the fundamentals look solid.

Meanwhile, household debt (as a percentage of gross disposable income) is at its lowest since the late 1990s, while the savings ratio of about 11% is more than twice its pre-Covid level.

As a result, although the labour market has softened, we continue to believe a spike in unemployment and a resulting recession are unlikely. Instead, we think there are two other scenarios that are far more likely and represent something of an each-way bet for the small-cap sector.

On the one hand, if employment doesn’t collapse, consumer confidence and spending should slowly increase. This would push up economic growth in the UK at a time when it is faltering in the US.

If the relative valuation disparity between US and UK stocks prompted a modest investor switch, fuelling flows into the UK, we anticipate that small-cap returns would be turbo-charged, given they benefit from greater domestic revenues.

On the other hand, if we are wrong, the status quo would continue: a rather moribund economy where, even though investors don’t return to UK smaller companies, low valuations would mean takeovers and share buybacks continue to drive returns.

We believe our portfolio would continue to be resilient in such an environment. Over the past 10 years, nine of which have seen net outflows from the UK small-cap sector, our fund has risen by more than 100%. That’s 8% a year against the FTSE All-Share’s 7% – a period that included Brexit and a global pandemic.