Artemis UK Smaller Companies Fund
Q1 2026 update

Performance

In the first three months of this year, the fund returned -11.0%, underperforming its benchmark's return of -6.9%. The fund's weak absolute performance was mainly driven by concerns about the conflict in Iran and the wider repercussions of higher inflation, higher interest rates and weaker business and consumer confidence. Its weak relative performance was due to several of its media and technology holdings being seen as threatened by artificial intelligence (AI).

Past performance is not a guide to the future. Source: Lipper Limited to 31 March 2026 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.

Detractors

Media and software stocks that suffered from the perceived threat of AI included Future, Next 15, LBG and GB Group. We see the risks as being overstated. We would highlight the strength of these companies' proprietary data, the opportunities AI may create and their valuations, which in some cases are extremely low. For instance, GlobalData derives 80% of its revenue from customers who subscribe to its proprietary industry data. Around 300 of its 350 datasets are proprietary (and therefore not available to third-party AI), driving high barriers to entry. Its software engineers have built agentic AI applications to allow customers faster and easier access to its data.

Some of the fund's consumer-facing stocks were also weak (for example MJ Gleeson and On the Beach). Although the Iran war has not changed our three-to-five-year outlook for these businesses, it has affected their near-term prospects.  Consumer confidence has been hit, inflation is higher and interest-rate expectations have changed.

Contributors

There were no obvious themes among our winners during the quarter:

• Ashtead Technology's results were slightly better than expected (the market had feared an earnings downgrade). 

• IG Group is a beneficiary of market volatility, which usually leads to increased levels of trading activity. In addition, improvements being made by the online trading platform's new chief executive are starting to gain traction.

• Bloomsbury Publishing (a new holding) announced the publication dates for the next two novels by bestselling author Sarah J Maas, prompting an upgrade in earnings expectations.

Purchases

We started a new holding in Tristel, which supplies chlorine dioxide for high-level disinfection of medical devices (for example ultrasound probes) in hospitals. Although the shares are not especially cheap (around a 5% free cashflow yield or 20x p/e) it has attractive financial characteristics. The company is growing revenues at 10 to 15% (all organically) and makes an 82% gross margin, which drives strong earnings growth. It is in the early stages of entering the US market, which has the potential to transform its business.

We increased our exposure to medical device manufacturer NIOX, which had lagged despite strong results. We also added to our recent new holding in DiscoverIE, which 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 a year ago, the company’s earnings forecasts have been upgraded by about 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 it is valued at under 15x earnings and more than a 6% free cashflow yield.

Sales

We sold our remaining holding in JTC after the recommended £2bn cash bid by private equity firm Permira. We also sold our small residual holding in Videndum, having decided not to participate in its refinancing. 

A rally in SSP's shares led us to sell our holding. Costs are being treated as 'exceptionals' (and therefore not affecting the ‘underlying’ profits) and profits are not being converted into cash due to higher capitalised intangible costs. We were not comfortable with its use of supplier finance deals, which improve the headline leverage and cashflows but do not always match the economic reality.

Most other sales involved trimming strong relative performers, including Serco, Coats and Secure Trust Bank.

Outlook

Events in the Middle East may have deferred a recovery in the UK smaller companies market. Higher inflation means interest-rate cuts may be delayed, weakening consumer sentiment. The Iran conflict does not, however, change our three-to-five-year outlook. We think it is worth emphasising the differences between the current situation and the 2022 inflation spike.

• The risk of knock-on inflationary impacts is lower than at the start of the Ukraine war because the labour market is significantly looser.  

• The movement in gas futures is (so far) much smaller than it was in 2022.

• The impact on non-energy related commodities (for example agricultural commodities) is far lower.

For our fund's portfolio, the main risk comes from its overweight to UK consumer discretionary stocks, which we have trimmed at the margin. Real incomes are now likely to be (broadly) flat this year because of higher inflation. Any growth in consumer spending will thus be reliant on the savings rate falling. Because of the high starting point for the UK household savings ratio (about 10%, double that of the US), there is still scope for consumer spending to exceed expectations once confidence recovers.

AI threats are overstated

The recent sell-off in 'AI-threatened' stocks is overdone, in our view. No one yet has clarity as to how disruptive AI will prove to be (and we will need to continue to test our views). Our belief that shares have been oversold is based on the following factors:

• Proprietary data: As agentic AI hoovers up public data, we think first-party, proprietary data will become more valuable. That should benefit companies such as GlobalData and YouGov.

• Low valuations: Valuations of stocks seen as ‘at risk’ are very attractive. If a share price is high, as an investor you need to be confident that your bull case is correct; but if a company trades on a low valuation, you only need to believe the bear case might be wrong. 

• Overlooked opportunities: Small caps typically underperform in the early stage of a crisis and then bounce back strongly thereafter. Part of this is due to their ability to be nimble – it is easier for them to adopt a new way of working or pivot to find new opportunities. Many of the companies seen as being most affected also have some of the biggest potential opportunities from using AI.

Opportunities when stock specifics are overlooked

Share-price moves in March (and in early April) have been dominated by geopolitical macro events, which are both fast changing and difficult to take a differentiated view on. At times like this, share prices can get disconnected from fundamentals and stock-specific news can easily be overlooked.

Social housing maintenance provider Mears is one example. In March, Mears reported strong results, upgraded its expectations for the year ahead and reported that its order book (of contracted future revenues) had increased by 38% to £4bn. Yet the shares were down 8% over the month. Over the past year, Mears’ 2026 earnings per share expectations have increased by 36% but the share price has fallen by 16%.

We believe the disconnect between Mears’ share price and its fundamental performance should be seen as an opportunity for active investors with a long-term perspective. We intend to take advantage of this and other similar situations that the current market environment is creating.