Artemis Funds (Lux) – US Smaller Companies update
Cormac Weldon and Olivia Micklem, managers of the Artemis Funds (Lux) – US Smaller Companies, report on the fund over the quarter to 31 December 2023 and their views on the outlook.
Source for all information: Artemis as at 31 December 2023, unless otherwise stated.
The fund returned 13.7% over the quarter, in line with the Russell 2000 index, which returned 14.0% (in US dollar terms).
Inflation in check?
As had been the case for most of the year, markets were fixated on inflation and the likely path the Federal Reserve would take in response to its trajectory. At the start of the quarter, it was widely accepted by the market that rates would remain higher for longer to combat stubborn inflation.
As the quarter progressed, it became clear that CPI inflation was trending lower towards the Federal Reserve’s target of 2%, supported by softening demand and a more balanced employment dynamic. The Federal Reserve confirmed the market's expectations in December when they signalled a pause in rate hikes, and went further, forecasting three rate cuts of 0.25% in 2024.
Small caps trump large caps
The improved economic outlook and moderation in interest rate expectations provided significant tailwinds to the smaller companies index during the period, especially in December when the Russell 2000 posted a 12.2% return (in US dollar terms).
Housing exposure drives performance
If you have read or listened to us talk about exposures in the fund you will have heard us discuss our belief in the US housing sector.
There are multiple aspects to this thesis. Broadly, there is a structural shortage in housing inventory in the US. Most mortgages are not portable and home owners are reluctant to move from a low mortgage rate to a high mortgage rate, meaning that recently they have tended to remain in their current houses and so secondary supply does not come on the market. This means that demand must be met with new build, favouring housebuilders and suppliers of building materials. In addition, household formation (couples choosing to live together and possibly have children) is also picking up because of shifts in demographics.
Aside from these supportive trends, these types of companies tend to perform well when interest rates have peaked and are likely to come down.
It was therefore encouraging to see our thesis play out over the quarter with solid performance coming from: TopBuild (insulation); Builders FirstSource (a distribution company to homebuilders) and Meritage, an out and out homebuilder.
Cosmetics add a glow
Our holding in e.l.f. Beauty, the cosmetics business, had a solid quarter, beating analysts’ expectations with revenue coming in 9% ahead of consensus and tracking towards our upside case for the company. A higher- growth company, it experienced some pain at the start of the quarter, but with an improved inflation and interest rate backdrop, had a very strong November and December.
Lattice Semiconductors holds back performance
Where there was weakness over the period, it was generally in holdings where we see a long-term opportunity, albeit with some short-term headwinds.
As an example, we hold a position in Lattice Semiconductors which performed poorly over the period. Our thesis is that Lattice will double revenue from gaining share in an expanding total addressable market over the next five years. The company has industry-leading margins and a low capital intensity 'fabless'1 manufacturing model. The industrial/analogue semiconductor market is currently going through a cyclical correction. We expect this to persist for a few more quarters but continue to hold a position in Lattice as it provides useful exposure to the semiconductor sector, and we remain confident in the long-term outlook for the company.
Outlook – Positive trends for smaller companies
With smaller companies in the US tending to be more sensitive than their larger peers to an improvement in macro-economic conditions, we are optimistic about the prospects for the asset class in 2024. We also see opportunities to deliver returns ahead of the index through our careful analysis of industry dynamics and company fundamentals.
We expect a continuation of strong performance in our housing-related holdings as well as the companies which will benefit from growth in infrastructure expenditure. From a secular point of view, we think that there will be a strong recovery in a couple of sectors which in 2023 were still suffering under the distorting impact of Covid. In particular we would highlight healthcare and life sciences, where we see demand returning to normal and our holdings in Avantor, and Repligen stand to benefit. The other industry we would expect to recover strongly is the memory-chip sector. We believe pricing is now stabilised, and is on the path to recovery given supply demand is much more in balance
Source: Lipper Limited/Artemis from 31 March 2023 to 31 December 2023 for class I Acc USD
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.
Benchmark: Russell 2000 TR; the benchmark is a point of reference against which the performance of the fund may be measured. Management of the fund is not restricted by this benchmark. The deviation from the benchmark may be significant and the portfolio of the fund may at times bear little or no resemblance to its benchmark.