Artemis Funds (Lux) – US Smaller Companies update

Source for all information: Artemis as at 31 March 2024, unless otherwise stated.

The fund returned 15.8% (in US dollar terms), outperforming its benchmark the Russell 2000 index, which returned 5.2% and its peer group (the IA North American Smaller Companies Average), which rose by 7.1%.

Economic resilience dampens the market's expectation of rate cuts

Despite the economy beginning to show signs of stress, it was still the view of the markets, and perhaps the Federal Reserve, that we are in the midst of a soft landing, with the US economy remaining remarkably robust in the face of higher rates. This resilience prompted the market to reign in optimism around the timing and number of rate cuts in the understanding that the main risk to the economy was rising inflation.

Small caps disappoint relative to their larger peers:

The optimism around the return of small-cap dominance as we entered 2024 has largely not borne out in the numbers with the S&P 500 up 11.6% and Russell 2000 up 6.1%.

In terms of sectors, technology once again led the way, with energy coming in second after tensions in the Middle East supported energy prices. Telecommunications proved to be the laggard, although the sector has a relatively small weight in the Russell 2000.

Fund produces strongly positive returns

On a relative basis the fund has had one of the best quarters of performance since its inception. The source of this outperformance can almost entirely be attributed to stock selection, particularly within our industrials holdings. We have also had notable contributions from the utilities and consumer discretionary sectors. Our underweight to the energy held back the fund's performance.

Industrials drive performance

The fund benefited significantly from its overweight to the Industrials sector over the period, accounting for around half of the outperformance. A diverse array of companies contributed to this. We highlight a few below.

Trucking continues its strong run

You will have heard us talk about Saia, our less than truckload company, countless times in our quarterly commentaries. It has been a business that has gone from strength to strength. Our initial thesis was geographic expansion into the northwestern states, as well as building out nationwide coverage. What we have seen since then is the business develop into an almost best-in-class carrier. There has also been a significant restructuring in the industry with the collapse of Yellow (another less-than-truckload carrier), that has allowed Saia to pick-up distribution terminals, thereby increasing its footprint as well as density of operations. It has also seen a pick-up in volume as Yellow’s has been redistributed.

Construction and materials holdings continue to perform strongly

Our holdings in Builders FirstSource, TopBuild, Eagle Materials and AZEK all supply materials and parts to the construction industry, in particular to the housing sector. They are experiencing a tailwind from a significant increase in demand for new builds that are being specifically tailored to new household formations. We see this support continuing as the US is currently short of housing and what it has is ageing.

Other contributors of note

Other top contributors come in the form of Constellation Energy (independent power producer), Comfort Systems (specialist contracting services), elf Beauty (cosmetics), nVent Electric (electrical equipment) and Core & Main (drainage systems).

On the negative side…

Dynatrace, an application monitoring business, suffered over the quarter when it lowered its revenue guidance. MarketAxess, the electronic trading platform for fixed-income securities, also saw a fall in its share price despite reporting strong Q4 earnings. There were concerns about market share loss in high-yield bonds which is an important market for them. Calix, the telecoms business, reported Q4 earnings ahead of analysts' expectations but released cautious guidance for Q1 2024 due to government support for broadband services causing a delay in demand for its appliances.

Activity

We trimmed some positions that have performed well, including Eagle Materials, elf Beauty, TopBuild, and Clean Harbors. We recycled the proceeds into areas that by our assessment offer better risk/reward. We would include Hyatt (the hotel chain), Core & Main (the drainage supplier) and Jones Lang Lasalle (the real estate broker). We also bought Shockwave Medical, a medical device company. Its share price had fallen in 2023 and we saw it as an attractive attractive entry point for a business where we see a significant revenue growth opportunity.

Outlook

After a strong period of relative and absolute performance, we are sometimes asked whether the opportunity remains the same both for the asset class and for the fund. Smaller companies' valuation discount relative to larger companies is a well-known phenomenon and remains intact. For the fund, we are not struggling to find opportunities, in fact quite the opposite. We are seeing a range of sectors still trading at depressed levels and we see many companies with idiosyncratic drivers to their growth that we believe will persist.