Artemis UK Smaller Companies Fund
Q4 2025 update

Overview

UK small caps lagged their larger counterparts by a considerable margin during 2025, which we think was mainly down to the lack of investor confidence in the domestic economy. Roughly 60% of small-cap revenues are earned in the UK, whereas it’s only 20% for FTSE 100 companies. This means that small caps are much more driven by how investors' views are influenced by media headlines, which were overwhelmingly negative in the run-up to November's Budget. We continue to see this as an opportunity to invest in market-leading brands on very attractive ratings, such as Dunelm, DFS, Moonpig, Greggs and Halfords.

Performance

The fund's performance was flat for the fourth quarter (a 0.1% return), compared with a small loss for its average peer (-0.4%) but a gain of 2.2% for the benchmark (the Deutsche Numis UK Smaller Companies index, excluding investment trusts). For the 2025 calendar year, the fund made 5.4% – enough to put it in the top half of its IA UK Smaller Companies sector (which gained 3.8%), but well behind the 12.7% made by its benchmark.

This time last year, we were bullish about the prospects for UK small caps. So far, we’ve been wrong. Investor confidence in the sector remains lacking. Politics has been a headwind. Frequent policy changes and the delayed Budget sapped confidence. Yet despite the tricky politics and dismal investor sentiment, the underlying performance of our companies has remained positive. To us as long-term investors, this is what is most important and bodes most positively for the future.

Past performance is not a guide to the future. Source: Lipper Limited to 31 December 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.

Positive contributors

Construction & materials was our top-performing sector in Q4, followed by travel & leisure, then banks. Norcros (bathroom and kitchen products), GB Group (fraud prevention), IG Group (online trading), Fuller, Smith & Turner (Fuller's pubs) and Mears Group (housing) made the strongest positive contributions to the fund's returns.

Norcros saw earnings upgrades despite a continued tough bathroom market as margins benefited from previous warehouse consolidation, as well as an accretive acquisition of a wall-board manufacturer in Norway.

Fuller's also saw upgraded earnings as interim profits rose by 28%. The company was more than able to pass on the extra National Insurance and national living wage costs from the previous Budget.

IG Group performed well after reporting improved trading, with organic revenues up 23% in the three months to 30 November 2025.

For GB Group, first-half results were merely in line with expectations, yet this was enough to prompt a modest rally, given how low its valuation had been.

Mears' share price made a partial recovery from weakness earlier in the year as it (yet again) increased its earnings expectations. 

Negatives

Our holdings in media, aerospace & defence and electricity detracted from returns during the quarter. Our lack of exposure to precious metals and mining stocks, which performed strongly, also hurt us.

The biggest stock-specific detractor was Telecom Plus, which reported lower interim profits (as expected) due to a rephasing of metering and other energy-related costs. There was also speculation it would acquire fellow energy provider Ovo. QinetiQ (which we sold), Future, Accesso Technology Group and Brooks Macdonald also underperformed in Q4

Purchases

We started new holdings in DiscoverIE and Bloomsbury Publishing during the quarter. DiscoverIE designs and manufactures specialist electrical components. These components typically represent a small portion of the total end product costs and can be expensive to replace mid-way through the lifecycle of the equipment. Since our previous meeting with the company a year ago, it has upgraded earnings forecasts by 5%, yet the share price has fallen by 15%. At the current valuation, we are buying into a group where management expects to grow earnings and free cashflow by double digits, yet the company is valued at under 15x earnings with a free cashflow yield of more than 6%.

With Bloomsbury Publishing, we felt an 8% free cashflow yield was attractive given its strong long-term record and the net cash position. Historically we have been put off by the hits-driven nature of the business, but we feel this is less of an issue now than in the past. Academic publishing is less lumpy than consumer sales and has increased to about one-third of the business. What's more, 70% of sales now come from the (more predictable) backlist. Harry Potter continues to account for more than 10% of revenues, 28 years after the first book was published, and the franchise should benefit from the new HBO series in 2027. Meanwhile, Disney has acquired the film rights for Katherine Rundell's novel Impossible Creatures.

Sales

We sold out of QinetiQ, Costain and Headlam during the quarter. Security and defence contractor QinetiQ has many attractive characteristics, in particular its capital-light and cash-generative business model. However, it remains heavily dependent on UK defence spending and, despite increases, budgets are under pressure from a growing number of competing priorities. Rising ‘specific adjusting items’ are holding back cash generation and, we worry, are indicative of a more challenging backdrop.

Costain's shares had run up a long way despite revenue softness and we were concerned that the infrastructure company's margin targets may not be achievable.

Flooring specialist Headlam has been persistently weak amid a market with growing competitive challenges.

Outlook

We are, if anything, even more excited about the future returns for UK small caps than we were this time last year. The operational performance of our companies has been solid if unspectacular, but their valuations sit well below their true worth.

Two pieces of evidence support this contention: first is the rate at which portfolio holdings are being taken over, at an average premium of close to 50%. In the past few months we have had cash bids for fund administrator JTC and a recommended offer for TT Electronics (albeit one that was subsequently voted down by shareholders), while software cyber consultant NCC is in talks to sell its escrow division or even the whole group.

Second is the number of portfolio holdings buying back shares, which has accelerated to a level we have never seen before. If the management teams allocating capital in this way anticipated a recession, they would retain their fire power rather than pushing the buyback button. The fact they are pressing on shows they do not believe the negative rhetoric. We also see a number of company directors buying their own shares.

What will be the catalyst that finally leads small caps to outperform? This only ever becomes apparent with the benefit of hindsight, but most likely in our view will be one of the following:

• If, as expected, there is no spike in unemployment, confidence should improve and consumer spending (which makes up 60% of the economy) would recover. The money is there – the savings ratio currently stands at 9.5%, close to twice its pre-Covid level. It is estimated that a single percentage point fall in this figure would provide a £17bn boost to the economy.
• As inflation trends lower, interest rates will continue to fall and mortgage rates will follow, stimulating the housing market. Savers will shift some of their now lower-yielding cash into higher-yielding alternatives such as shares.

If we are wrong and there is a major recession, small caps will take a hit. However, given low debt levels among most of our holdings (the median company in the portfolio is forecast to have no net debt this year), they will be able to trade through. While small caps tend to underperform in the year a recession starts, they also outperform in the subsequent year, making up all the lost ground.